Green and Sustainable Finance: Principles and Practice in Banking, Investment and Insurance (Chartered Banker Series, 7) [2 ed.] 1398609242, 9781398609242

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‘Simon Thompson has produced an outstanding and essential read for anyone in finance and banking who needs to better understand green and sustainable finance. The book helps the reader understand how to begin to align, embed, measure and use green finance and grapple with making the green transition as individuals, firms and communities. It is accessible, clear, well-constructed and addresses a myriad of complex issues while treating the reader with respect, without jargon. If you need to understand how to operationalize a firm’s profitable pathway to net zero, you should buy this book and digest its lessons. Stuart P M Mackintosh, Executive Director, G30 and author of Climate Crisis Economics ‘An accessible and timely contribution to the literature. The revised text is case rich, international in approach and contains many reflective exercises to enable and provoke contemplation of the major decisions confronting finance and financial institutions, now and during the coming time of climate change.’ John Ashton, Professor of Financial Regulation, University of York ‘As green and sustainable finance increasingly becomes the norm, the ability to integrate climate considerations into financial decision making is also becoming a critical skill for all financial professionals. Simon Thompson’s updated and comprehensive textbook explains the latest concepts, trends, risk frameworks, regulations and investment tools that all bankers and investors need to keep pace with this rapid transformation of the financial sector.’ Rhian-Mari Thomas, Chief Executive Officer, Green Finance Institute ‘This new edition highlights the way biodiversity and social focus are now woven into effective green finance. It considers the host of new metrics, new measurement bodies and new financial products, and offers a nuanced lens on transition finance as well as on emerging risks. Green finance has matured in giant steps since the first edition of this book. Valuable then, this edition is compelling now.’ Susan Rice, Chair, Financial Services Culture Board ‘Provides key contextual knowledge by clearly and concisely situating green and sustainable finance in reference to key sectors – banking, insurance, bonds, equity funds, regulation, etc – making this an essential read for all financial services practitioners and policymakers.’ Omar Shaikh, Director and Co-Founder, Global Ethical Finance Initiative

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CHARTERED BANKER SERIES Culture, Conduct and Ethics in Banking Fred Bell Retail and Digital Banking John Henderson Commercial Lending Adrian Cudby Relationship Management in Banking Steve Goulding and Richard Abley The above titles are available from all good bookshops. For further information on these and other Kogan Page titles, or to order online, visit the Kogan Page website at: www.koganpage.com.

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GREEN AND SUSTAINABLE FINANCE

SECOND EDITION

PRINCIPLES AND PRACTICE IN BANKING, INVESTMENT AND INSURANCE

SIMON THOMPSON

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Publisher’s note Every possible effort has been made to ensure that the information contained in this book is accurate at the time of going to press, and the publishers and author cannot accept responsibility for any errors or omissions, however caused. No responsibility for loss or damage occasioned to any person acting, or refraining from action, as a result of the material in this publication can be accepted by the editor, the publisher or the author.

First published in Great Britain and the United States in 2021 by Kogan Page Limited Second edition published in 2023 Apart from any fair dealing for the purposes of research or private study, or criticism or review, as permitted under the Copyright, Designs and Patents Act 1988, this publication may only be reproduced, stored or transmitted, in any form or by any means, with the prior permission in writing of the publishers, or in the case of reprographic reproduction in accordance with the terms and licences issued by the CLA. Enquiries concerning reproduction outside these terms should be sent to the publishers at the undermentioned addresses: 2nd Floor, 45 Gee Street London EC1V 3RS United Kingdom

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4737/23 Ansari Road Daryaganj New Delhi 110002 India

www.koganpage.com Kogan Page books are printed on paper from sustainable forests. © Simon Thompson, 2021, 2023 The right of Simon Thompson to be identified as the author of this work has been asserted by her in accordance with the Copyright, Designs and Patents Act 1988. ISBNs Hardback 978 1 3986 0926 6 Paperback 978 1 3986 0924 2 Ebook 978 1 3986 0925 9 British Library Cataloguing-in-Publication Data A CIP record for this book is available from the British Library. Library of Congress Control Number 2022951122 Typeset by Integra Software Services, Pondicherry Print production managed by Jellyfish Printed and bound by CPI Group (UK) Ltd, Croydon, CR0 4YY

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CONTENTS Preface  ix Acknowledgements  x Sir Roger Gifford – an appreciation  xi



Introduction: About Green and Sustainable Finance: Principles and practice in banking, investment and insurance 1

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An introduction to green and sustainable finance 5 Introduction 5 Sustainable finance 6 Green finance 8 The dimensions of green finance and sustainable finance 21 Challenges for green and sustainable finance 31 Opportunities for green and sustainable finance 35 The UN Sustainable Development Goals 37 Key concepts 44 Review 44 Notes 48

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Climate change and our changing world 52 Introduction 52 Our changing planet 53 The climate system and anthropogenic climate change 57 Climate change and the finance sector 81 Supporting the transition to a sustainable, low-carbon economy 88 Key concepts 94 Review 95 Notes 98

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Building a sustainable financial system: International, national, industry and institutional responses 104 Introduction 104 Global policy responses to climate change and sustainability 105 Finance sector initiatives to support the growth of green and sustainable finance 134

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Institutional responses – embedding sustainability into strategy 142 Key concepts 153 Review 154 Notes 157

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Measuring and reporting impacts, alignment and flows of green and sustainable finance 163 Introduction 163 Monitoring, measuring and reporting: impacts and outcomes 164 Monitoring the alignment of lending and investment portfolios with the Paris Agreement 186 Monitoring, measuring and reporting: tracking flows of climate finance 191 The data challenge 196 Key concepts 199 Review 199 Notes 204

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Risk management 208 Introduction 208 Introduction to climate, environmental and sustainability risks 209 Classification of climate, environmental and sustainability risks 214 The evolving regulatory response to climate, environmental and sustainability risks 230 Pricing climate-related and environmental risks – putting a price on carbon 253 Key concepts 259 Review 260 Notes 263

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Responsible retail, commercial and corporate banking 269 Introduction 269 The role of banking in the transition to a sustainable, low-carbon world 270 UN Principles for Responsible Banking and Net Zero Banking Alliance 275 Retail banking products and services 281 Corporate and investment banking products and services 301 Key concepts 319 Review 320 Notes 323

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Green and sustainable bonds 328 Introduction 328 Introduction to debt capital 329 Green bonds 331 Other types of green and sustainable bonds 351 Green and sustainable bond listings, indices and funds 359 Securitization 367 Key concepts 369 Review 369 Notes 373

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Central and development banks 380 Introduction 380 The role of central banks 381 The role of development banks 402 Key concepts 422 Review 422 Notes 425

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Responsible and sustainable investment 429 Introduction 429 Introduction to investment 430 Introduction to responsible and sustainable investment 432 Responsible and sustainable investment products and services 458 Challenges to the continued growth of responsible and sustainable investment 479 Key concepts 486 Review 487 Notes 491

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Insurance – impact underwriting 498 Introduction 498 The role of insurance in the financial system 499 The insurance sector and climate-related risks 500 UN Principles for Sustainable Insurance and the Sustainable Insurance Forum 506 Promoting sustainability through insurance – impact underwriting 507 Climate (climate risk) insurance 523 Key concepts 530 Review 530 Notes 533

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Green and sustainable FinTech 536 Introduction 536 Introduction to FinTech 536 Applying FinTech tools and techniques in green and sustainable finance 540 Policy and finance sector initiatives to support FinTech in green and sustainable finance 557 Costs and challenges of FinTech 564 Key concepts 567 Review 568 Notes 570

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The future of green and sustainable finance 573 Introduction 573 Progress in aligning finance with sustainability 574 Challenges to the growth and mainstreaming of green and sustainable finance 584 Emerging areas of interest in green and sustainable finance 594 Your role and future as a green and sustainable finance professional 609 Key concepts 626 Review 626 Notes 629 Index 633

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PREFACE Successfully limiting global warming to below 2°C – ideally 1.5°C – above pre-industrial levels requires a systemic global transition. Every economic activity, and every economic entity, will be impacted, and the scale, scope and pace of change required is unprecedented. Financing this transition requires the rapid decarbonization and redeployment of global capital, and the alignment of the finance sector with the objectives of the Paris Agreement so that, in Mark Carney’s words, ‘every professional financial decision takes climate change into account.’ Ambitious, collective action is being taken by many financial institutions, such as the 450 firms comprising the Glasgow Financial Alliance for Net Zero (GFANZ), launched in 2021. GFANZ members commit to using science-based guidelines to reach net zero by 2050 at the latest and have set challenging interim targets for 2030. Achieving such targets and aligning finance with the objectives of the Paris Agreement, and sustainability more broadly, requires equally ambitious, collective action to develop the knowledge and expertise of finance professionals worldwide to ensure the finance sector has the capacity and capabilities required. This requires much more than increasing the number of climate and sustainability professionals working in finance, welcome though this is. To pass the ‘Carney Test,’ every finance professional needs to develop and apply a knowledge and understanding of the principles and practice of green and sustainable finance appropriate for their role, function and the organization they work for. And, as we try to ‘build back better’ from the Covid-19 pandemic, we must consider wider aspects of environmental sustainability – particularly biodiversity – and social sustainability, aligning finance not only with the objectives of the Paris Agreement but with the UN Sustainable Development Goals too. Sustainable prosperity must be more fairly shared, and the interests of current and future generations taken into account. Helping companies, communities and countries rebuild in an economically, environmentally and socially sustainable manner not only offers commercial opportunities for the finance sector; it also provides an opportunity for our finance profession to demonstrate our sense of social purpose. To build the capacity and capability required to align finance with sustainability, and embed a culture within financial services based on green and sustainable finance principles and values, we need to educate large numbers of individuals so that current and future generations of finance professionals can deploy the tools and techniques of green and sustainable finance in their professional practice. Only then will every professional financial decision take climate change – and broader aspects of sustainability – into account, and will we truly align finance and sustainability.

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ACKNOWLEDGEMENTS Jason Lowe, Dan Williams, Ailsa Barrow and Katrina MacNeill from the UK Met Office kindly provided much of the authoritative and up-to-date content relating to climate science that underpins much of Chapter 2; the essential foundation of knowledge required by all Green and Sustainable Finance Professionals. In addition, for their assistance with and contributions to earlier editions of this book and course I would like to thank Hannah Duncan for her significant input to the previous (2021) edition; Dr. Ben Caldecott, the founding Director of the Oxford Sustainable Finance Programme at the University of Oxford Smith School of Enterprise; our colleagues and friends at the Finance Innovation Lab (Gemma Bone, Anna Fielding, Laurie MacFarlane and Robert Nash) for their substantial contributions to the original version of this book in 2018; Olga Shchehrykovich for her comments on risk which helped shape Chapter 5; and Andrew Voysey for his guidance on the development of the original Green and Sustainable Finance syllabus. I would also like to warmly thank my colleagues at the Chartered Banker Institute, particularly Lynn McLeod, Caroline Murray, Simon Bailey, Vikki Duncan, Mark Roberts and David Kennedy for their help with this and previous versions of Green and Sustainable Finance: Principles and Practice.

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SIR ROGER GIFFORD – AN APPRECIATION The first edition of Green and Sustainable Finance contained a foreword by Sir Roger Gifford, a former Lord Mayor of London and founding Chair of the Green Finance Institute. Sir Roger, who sadly passed away in May 2021, was a leading advocate and ambassador for green finance; acknowledged, admired and respected globally for his expertise in and passion for the subject. In 2017 Sir Roger – a very active and proud Honorary Fellow of the Chartered Banker Institute – encouraged us to develop our first green finance training programmes, which in time became the Certificate in Green and Sustainable Finance which this book was written to support. Without his infectious enthusiasm for the subject, and very active championing of the Institute and the Certificate, it would not have become the global benchmark qualification it is today. Sir Roger’s contribution to the practice and growth of green and sustainable finance, and to banking, business, education and public life, cannot be overstated. He is fondly and warmly remembered by the many individuals and organizations he inspired, including the Fellows and Members of the Chartered Banker Institute. It is probable you would not be reading this book if it were not for Sir Roger; we are all in his debt – not least I. Simon Thompson FCBI Chief Executive Chartered Banker Institute

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Introduction: About Green and Sustainable Finance: Principles and practice in banking, investment and insurance Introduction Finance plays a key role in addressing climate change and wider environmental and social challenges – in fact the critical role of finance in tackling climate change is spelt out in Article 2.1 (c) of the Paris Agreement. A successful global transition to net zero requires green and sustainable finance principles and practice to be embedded across the whole financial system to a point where, in Mark Carney’s words, ‘every professional financial decision takes climate change into account’ (and, we argue, other aspects of sustainability too). Aligning finance with the objectives of the Paris Agreement, the UN Sustainable Development Goals and broader sustainable objectives benefits not only society, but finance and financial institutions too. Developing the capacity and capabilities within financial institutions that enable them to identify, disclose and manage climate, environmental and sustainability risks enhances organizational resilience and that of the financial system overall. It also helps financial institutions identify and take

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Introduction

advantage of opportunities to invest in the transition, and support customers’ and clients’ transitions too. Supporting sustainable growth, resilience and prosperity – globally, nationally and locally – is good for finance and good for society. Green and Sustainable Finance, authored by the Chartered Banker Institute’s Chief Executive, Simon Thompson, is written to support the Institute’s Certificate in Green and Sustainable Finance, the global benchmark qualification for financial services professionals globally who wish to develop and demonstrate their knowledge and expertise of green and sustainable finance. It has wider applicability, though, and will help all finance professionals and students of finance develop their understanding and application of green and sustainable finance principles and practice.

Introduction to the 2022–23 version Substantially revised for 2022–23, Green and Sustainable Finance includes the latest assessment of climate science from the IPCC (AR6), published in 2021 and 2022, which shows that human activities are having unprecedented and irreversible effects on the global climate. Global surface temperatures are likely to rise under all scenarios by more than 1.5oC above pre-industrial levels by 2040 and by more than 2oC later in the century without dramatic and sustainable reductions in greenhouse gas emissions. This underpins the urgency and importance of aligning finance with the objectives of the Paris Agreement, and sustainability in general. Four chapters in this revised version of Green and Sustainable Finance have been largely rewritten: ●●

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Chapter 4 – to include much greater coverage of the reporting of environmental impacts and carbon accounting, including financed emissions (introducing PACTA and SBTi), the new International Sustainability Standards Board (ISSB) and sustainability reporting more generally. Chapter 5 – to include regulatory and market developments in climate and environmental risk management, and in particular the work of the Network for Greening the Financial System and national financial regulators. Chapter 9 – to take account of the rapid growth of sustainable investment, and the increasing adoption of ESG and sustainable investment strategies. Chapter 12 – reviewing key themes from throughout the book and course, assessing progress and barriers to aligning finance with the Paris Agreement and the UN Sustainable Development Goals, and introducing emerging areas of green and sustainable finance.

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In addition, the book has been updated throughout to include: ●●

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Policy and regulatory developments at global, regional (EU), national and financial sector level. Market developments, including the growth of the green and sustainable bond market, sustainability-linked loans and new/updated market standards, frameworks and guidance such as the Green Bond, Social Bond and Sustainability-Linked Bond Principles. The latest finance sector alliances and initiatives, including the COP26 Private Finance Strategy and Glasgow Financial Alliance for Net Zero (GFANZ). An increasing focus on transition finance, plus broader social aspects of sustainability. Emerging areas for green and sustainable finance, including nature-based finance, the work of the TNFD and ocean finance.

Approaching green and sustainable finance with INTEGRITY As a rapidly developing field, green and sustainable finance is characterized by an increasingly wide range of regulations, principles, standards, frameworks, guidelines and other requirements aiming to align finance (or parts of finance) with sustainability, bring consistency and clarity to the practice of green and sustainable finance, and avoid greenwashing. We introduce and examine many of these in this book. These are necessary but not sufficient, however, for truly aligning finance and sustainability. As we will see in the following chapters, this requires deep cultural change within financial institutions and across finance, so that in UN Special Envoy Mark Carney’s words ‘… every professional financial decision takes account of climate change’ (and broader sustainability factors too), and every finance professional incorporates sustainability within their daily practice and activities. To do this, finance professionals should approach green and sustainable finance with INTEGRITY. As such, you should: I – Integrate sustainability into your professional practice, using your finance and general business expertise and skills, rather than think of this as a separate body of knowledge to be applied only from time to time. N – Nurture and nourish the culture of your team(s) and, where you can, your organization to establish professional norms aligned with the objectives of the Paris Agreement and UN Sustainable Development Goals. Ultimately, sustainability should not form part of an organization’s strategy but rather must be embedded in a firm’s purpose and culture.

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T – Target transparency: measuring progress and reporting the positive and negative environmental and social impacts of financial decisions is critical in order to monitor progress towards the objectives of the Paris Agreement, and other sustainability goals. E – Engage with established principles and guidance: you should follow established principles, standards, frameworks and guidance wherever possible, and encourage other finance professionals to do the same. G – Give professional advice and guidance to your customers, clients and colleagues that prevents greenwashing: you should take active steps, including exercising your professional judgement and professional scepticism, to avoid both deliberate and inadvertent greenwashing. R – Take responsibility: you and your organization must hold yourselves accountable and take responsibility for the impacts of your strategies, activities, operations and decisions. I – Inspire an inclusive approach: you should appreciate that a successful whole economy transition requires working with customers, clients, colleagues, communities and a wide range of external stakeholders to create shared and sustainable prosperity for all. You need to work beyond the boundaries of your own organization, and share good practice with others. T – Think long-term: a short-term focus on financial returns is incompatible with a successful net zero transition by 2050, and with creating shared, sustainable prosperity for all. Different finance professionals may have different time horizons (e.g. banking: 3–5 years, pensions: 50 years) but all need to adopt a longer-term perspective. Y – You, the finance professional, can make a difference! Continue to develop, apply and share your knowledge of green and sustainable finance so that best practice in some institutions in various countries becomes standard practice across banking and finance everywhere. Please bear these principles of INTEGRITY in mind as you read, and hopefully enjoy, this book, and do your best to put them into practice.

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An introduction to green and sustainable finance Introduction Green and sustainable finance is becoming increasingly mainstream. ‘Net zero’ policy commitments, regulation and market forces are combining to align financial institutions, and their strategies, activities and operations with the aims and objectives of the Paris Agreement and other sustainability goals. The most recent comprehensive assessment of climate science, published by the International Panel on Climate Change (IPCC) in August 2021, forecasts that temperatures are likely to rise by more than 1.5°C above pre-industrial levels by 2040 and by more than 2°C later in the century. Dramatic reductions in greenhouse gas emissions are required to prevent further global warming; the finance sector and finance professionals can play a leading role in tackling climate change, and other environmental and social issues. Finance is uniquely positioned to lead the transition to a low-carbon, more sustainable world, as we will explore throughout this book. There is a significant commercial opportunity for the finance sector and the banking and finance professions to demonstrate their positive social purpose. In this introductory chapter, we explore the dimensions of green and sustainable finance and provide an overview of green and sustainable finance today.

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L E A R N I N G OB J ECTI VES After reading this chapter, you should be able to: ●●

Define green and sustainable finance, and distinguish between these and related terms.

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Describe a range of approaches to green and sustainable finance.

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Describe the opportunities and challenges for green and sustainable finance.

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Describe the UN Sustainable Development Goals (SDGs).

Sustainable finance Context In the aftermath of the Global Financial Crisis of 2008, a strong consensus emerged from policymakers, regulators, civil society and financial services professionals themselves that some (although not all) financial institutions had engaged in too many short-term, harmful financial activities without any underlying, positive social purpose. It was felt that financial institutions, and the finance sector, needed to fundamentally reconsider their strategies, operations and activities. They should align with socially purposeful, longer-term aims to deliver greater economic and social value. Finance, in short, should become more ‘sustainable’.

Defining ‘sustainability’ While definitions vary, ‘sustainable’ and related terms, including ‘sustainable development’and ‘sustainability’, generally refer to: ‘… meeting the needs of current generations without compromising the ability of future generations to meet their needs’. This definition was first coined in the Report of the World Commission on Environment and Development, commonly known as the Brundtland Report. The report has been widely cited since it was published in 1987.1 ‘Needs’ may be wide and varied, but many approaches to sustainability focus on three key aspects, often described as a ‘three-legged stool’: 1 economy 2 environment 3 society

An introduction to green and sustainable finance

This is the approach we follow throughout this book. Other, similar approaches include the ‘triple bottom line’ accounting framework incorporating social, environmental and financial components (often referred to as ‘people, planet and profit’), and the environmental, social and governance components used in ESG investment strategies.

Defining ‘sustainable finance’ In the aftermath of 2008, there was a strong focus on making financial institutions themselves more sustainable. More recently still, the emphasis has been more on how finance can support sustainable economies and societies in general – including by protecting and enhancing the natural environment. ‘Sustainable finance’, therefore, encompasses: ●●

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making the activities and operations of banks, asset managers, insurers and other financial institutions more sustainable, including but not limited to considering broader economic, environmental and social factors (e.g. reducing a firm’s carbon footprint, implementing responsible lending policies, adopting an inclusive approach to recruitment, treating suppliers fairly) in an organization’s strategy and management; and financing sustainable economic, environmental and social objectives, often those set out in the UN Sustainable Development Goals (introduced later in this chapter).

These two factors go hand in hand, and it is hard to see how individuals and institutions could successfully identify and provide finance for sustainable economic, environmental and social objectives without adopting sustainable principles and practices within their own organization. For the purposes of this book, therefore, we define sustainable finance as: The inclusion of economic, environmental and social factors in an organization’s strategy, management, activities and operations, combined with the financing of sustainable economic, environmental and social objectives.

A term often used in the context of sustainable finance is ‘ESG’, which refers to the way organizations take account of and manage environmental (E), social (S) and governance (G) factors in their operations and activities (and, in the case of financial institutions, in their lending and investment decisions). As we will explore further below, and elsewhere in this book, ESG focuses on how organizations incorporate these three factors. A broader sustainability/sustainable finance approach also considers the economic, environmental and societal impacts – both positive and negative – of an organization’s activities, operations and lending and investment decisions. Whilst many use the terms ‘ESG’ and ‘sustainable’ interchangeably, there is an important

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difference between them as, ultimately, it is the impacts we need to measure in order to monitor what progress is being made towards a more sustainable, low-carbon world. Since the Paris Agreement on Climate Change in 2015, policymakers, regulators and financial services practitioners have focused on environmental sustainability, and addressing the causes and impacts of climate change. This has included significantly increasing the financing of new technologies and activities designed to reduce greenhouse gas emissions (‘climate change mitigation’) and/or support climate-resilient development (‘climate change adaptation’) as well as identifying and disclosing climate-related and other environmental risks. More recently, in response to the greater prominence of social issues (e.g. the ’Black Lives Matter’ movement) and demands to ‘build back better’ (i.e. more equitably) following the Covid-19 pandemic, social sustainability issues have attracted greater focus as have a wider range of environmental issues beyond climate change, such as addressing biodiversity loss on land and in the oceans.

QUICK QUESTION What are some of the key social issues facing the country where you live and/or work? To what extent are these currently being addressed by the finance sector?

Green finance Context All green investments must be genuinely environmentally sustainable to be accurately described as such, otherwise this would be ‘greenwashing’ – a term defined and explored later in this chapter. For example, it is clearly not environmentally sustainable to continue to extract and burn fossil fuels at the rate we currently do since at the very least this means there will be insufficient resources in future, and in some scenarios large parts of the planet will be rendered uninhabitable due to global temperature rises (we explore the science and impacts of greenhouse gas emissions and global warming in Chapter 2). Nor could an economic activity be described as sustainable if it resulted in significant benefits today, but led to substantial detriment to future generations. ‘Sustainable’ is often used synonymously, or in conjunction with, ‘green’, as in the title of this book. There are important differences, however. In practice, the great majority of green investments – particularly those that support climate-resilient development and other climate change adaptation activities – may also be described as

An introduction to green and sustainable finance

sustainable. For the most part, they seek to preserve (or enhance) the environment for the benefit of current and future generations, and may deliver a range of economic, environmental and social benefits – or, at least, mitigate economic, environmental and social harm caused by climate change. It is possible, however, for an investment (or activity) labelled as ‘green’ not to be considered by some as ‘sustainable’ in certain respects. Investment in renewable energy combined with the closure of thermal coal power generation plants, for example, could lead to significant job losses among those working in the plants, in the coal mines supplying fuel and in a wide range of supporting sectors. If that employment is concentrated in a relatively small region, this could have a substantial economic and social impact on current and future generations. The investment might not, therefore, be considered fully sustainable because current and future generations, at least in the region in question, are likely to be significantly disadvantaged, albeit for what many might argue is a greater overall good. The impact of a transition such as this could be mitigated by investing in training and development to enable workers to reskill and find new employment in the renewable energy and supporting sectors. Incentives might be deployed to encourage clean energy companies and others to establish themselves in a region traditionally reliant on fossil fuel extraction and production. Supporting workers and communities negatively impacted by the transition to a sustainable, low-carbon world and helping current and future generations benefit from this, is known as the ‘just transition’ – ensuring that the switch from a high- to a low-carbon economy is fair for current as well as future generations, and that the transition is truly sustainable in the broadest sense. In practice it seems difficult, if not impossible, for any genuinely sustainable approach to finance not to incorporate environmental factors, particularly those relating to climate change mitigation and adaptation, climate-related risks and biodiversity. It seems equally difficult for green finance to avoid considering the broader aspects of sustainability, including economic and social costs. To succeed, climate change mitigation and adaptation projects and activities require the active support of communities and societies impacted by climate change, and the projects and activities developed to tackle it. We should think, therefore, of green and sustainable finance being highly interrelated, with green finance being a major and integral element of sustainable finance overall. This is the approach we adopt throughout this book, and we generally refer to ‘green and sustainable finance’ except where the context specifically requires the use of a single term. Green and sustainable finance is one of several terms used to label activities related to the interaction between the economy, environment, society and finance. Related terms include ‘Responsible Banking’, ‘Responsible Investment’, ‘Environmental, Social and Governance’ (‘ESG’), ‘Sustainable Finance’ and ‘Climate Finance’. These are often treated synonymously, but as described above there are important differences

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between ‘ESG’ and ‘sustainability’/’sustainable finance’, with the latter focusing more on impacts. There are also differences in their scope, particularly in terms of whether they focus on climate and environmental issues or incorporate a wider range of social and governance issues. The United Nations Environment Programme (UNEP) describes those issues as:2 ●●

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Environmental issues: the quality and functioning of the natural environment and natural systems including biodiversity loss; greenhouse gas emissions, renewable energy, energy efficiency, natural resource depletion or pollution; waste management; ozone depletion; changes in land use; ocean acidification and changes to the nitrogen and phosphorus cycles. Social issues: the rights, well-being and interests of people and communities including human rights, labour standards, health and safety, relations with local communities, activities in conflict zones, health and access to medicine, consumer protection and controversial weapons. Economic issues: investee impacts on economic conditions at local, national and global levels. Including direct financial performance and risk, and indirect impacts such as through employment, supply chains and provision of infrastructure. Governance issues: the management of investee entities. Including board structure, size, diversity, skills and independence; executive pay; shareholder rights; stakeholder interaction; disclosure of information; business ethics; bribery and corruption; internal controls and risk management; and, in general, issues dealing with the relationship between a company’s management, its board, its shareholders and its other stakeholders.

Approaches which embrace the full range of these issues and seek to assess impacts are more likely to be termed ‘sustainable finance’, whereas those that focus mainly on environmental issues are more likely to be termed ‘green finance’. Advocates for a sustainable finance approach argue that it is not possible to separate the environment from society: society depends on the environment for its existence, and human society has a major impact on the environment. Understanding and measuring the positive and negative impacts of finance on the environment and society are key to aligning finance and sustainability. Many of today’s most pressing environmental issues impact disproportionately on those with the fewest resources, in both high-income and low-income countries, and the need to improve standards of living and reduce inequality cannot be separated from the need to protect our environment. In 2015, the United Nations defined and adopted its Sustainable Development Goals (SDGs) to encourage governments, business and civil society to tackle these wider issues of sustainability. The SDGs are explained in more detail later in this chapter, and we will return to them throughout the book.

An introduction to green and sustainable finance

Where the concern is only with preventing or responding to climate change, the term ‘climate finance’ may be used. Climate finance is also used specifically to refer to the UN climate change negotiations (the United Nations Framework Convention on Climate Change – UNFCCC) and the provision of finance from developed countries to developing countries to help with climate change mitigation and climate adaptation. The Paris Agreement, part of the UNFCCC process, aims to limit increases in the global average temperature to below 2°C above pre-industrial levels, and ideally below 1.5°C. We will explore climate science, and the most recent assessment of this by the International Panel on Climate Change (IPCC), in Chapter 2. One of three objectives set out in Article 2 of the Paris Agreement – Article 2.1(c) – commits signatories to making financial flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development. The recognition of the key role of finance in tackling climate change has made a major contribution to the growth of green finance, and we will return to this throughout this book. The UNFCCC and the Paris Agreement are explored in more detail in Chapters 2 and 3.

Defining ‘green finance’ Although the term ‘green finance’ is now used regularly by governments, central banks and regulators, financial services firms, NGOs, academics, finance professionals and others, there is no universal definition of the term. It can refer to some or all of: ●●

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the role of finance in allocating capital for wider, more sustainable purposes, in particular aligning financial institutions’ strategies and activities with the Paris Agreement; finance sector initiatives to tackle climate change and promote environmental sustainability; an emerging sector of financial institutions focused on environmental objectives; a focus on the use of lending and investment to either benefit the environment or reduce environmental harm; managing environmental and climate-related risks; the products, services, sectors and projects that may be supported by green and sustainable finance; and policy, regulatory and market initiatives, instruments, standards and frameworks.

This list is not exhaustive. As green and sustainable finance becomes more mainstream, many more activities are being promoted as ‘green’ and/or ‘sustainable’. Assessing the extent to which activities are truly green and sustainable, and avoiding ‘greenwashing’, are major themes of this book.

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A helpful way to consider the scope of green finance is to think of it in terms of both ‘financing green’ and ‘greening finance’: ●●

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Financing green refers to increasing flows of finance to support green and sustainable development objectives. This includes aligning lending and investment portfolios with climate and environmentally positive assets and investments, including those supporting the transition to a more sustainable, low-carbon world and shifting finance away from financing firms and sectors that are not transitioning, or not transitioning rapidly enough, to more sustainable business models. Greening finance refers to integrating sustainability within financial institutions’ strategies and activities, and across financial services as a whole. This includes identifying and disclosing climate-related financial risks – and, increasingly, broader environmental and sustainability risks, at both firm and sector levels.

‘Financing green’ and ‘greening finance’ are not opposing goals – they reinforce each other. For this book we have developed a general definition of ‘green finance’ that combines aspects of the above. For the Chartered Banker Institute, green finance encompasses the finance sector’s strategic approach to meeting the challenges of climate change and the transition to a more sustainable, low-carbon world, incorporating both ‘financing green’ and ‘greening finance’. Green finance, therefore, is: Any financial initiative, strategy, product or service designed to protect the natural environment and support the transition to a sustainable, low-carbon world, and/or to manage climate-related and other environmental risks impacting finance and investment.

This is a broad definition. It acknowledges the different aspects of green finance, with an overarching focus on protecting and enhancing the natural environment, and managing current and future environmental risks – particularly, but not exclusively, climate change. It highlights and recognizes the two-way nature of the relationship. Finance and investment can help or harm the environment and society, while the environment and society can also positively or negatively impact the performance of investments and financial services firms.

QUICK QUESTION We have just defined ‘green finance’. But what, in your view, does ‘green’ itself mean? How do we know when a product, service or activity is green – and when it is not?

An introduction to green and sustainable finance

Different shades of green To support the growth of green finance, at the most basic level policymakers, regulators, financial services firms, clients and customers must agree on which products, services and activities are ‘green’, i.e. environmentally sustainable. And, equally importantly, which are not (these are sometimes referred to as ‘brown’, i.e. unsustainable). For example: ●●

●●

Are electric vehicles genuinely ‘green’ if produced in factories dependent on fossil fuels for power generation and other aspects of manufacturing, and if the minerals required for their batteries are extracted at significant cost to the environment? Is a shift from coal-fired power generation to gas-fired generation ‘green’, since greenhouse gas emissions will be reduced, but not eliminated?

These are not academic, theoretical debates, and issues such as these are debated at length by policymakers, regulators and financial services practitioners developing taxonomies (introduced below) and other tools that try to define what is ‘green’. As we will explore throughout this book, agreeing what is ‘green’ (and what isn’t) is key in determining what can be financed using, for example, green bonds and green loans, or included in green and sustainable investment funds. Part of the difficulty is that ‘green’ is not a case of one-size-fits-all. Different regions, countries, sectors and firms will require different approaches and (possibly) slightly different definitions to ensure a successful transition to a sustainable, low-carbon world. It is as important to recognize and support the transition to green as it is to recognize and finance firms, projects and activities that are green. This is often referred to as ‘transition finance’ and is another key theme of this book. As firms and sectors transition from high- to low-carbon means of production and distribution, they will not usually become ‘green’ overnight. The transition takes time, although ideally it should be aligned with the goals and timescales of the Paris Agreement. The finance sector needs to provide transition finance to support those making the transition – and must recognize that the extent and pace of transition will vary between firms and sectors, and across geographies. Green and sustainable finance is not, therefore, purely focused on financing those economic activities that are 100 per cent green and sustainable (often referred to as ‘bright green’ or ‘deep green’). Rather, it needs to consider a wide spectrum of shades of green, as captured in the following reading.

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Green and Sustainable Finance

READING ‘50 shades of green’3 Financial markets increasingly recognize that sustainable investment is the new horizon that can bring enormous opportunities ranging from transforming energy to reinventing protein. For sustainable investment to go truly mainstream, it needs to do more than exclude incorrigibly brown industries and finance new, deep green technologies. Sustainable investing must catalyse and support all companies that are working to transition from brown to green. Such ‘tilt’ investment strategies, which overweight high environmental, social and governance (ESG) stocks, and ‘momentum’ investment strategies, which focus on companies that have improved their ESG rating, have outperformed global benchmarks for close to a decade. The mainstreaming of such strategies and the tools to pursue them are essential. At present, one of the biggest hurdles to doing so is the inconsistent measurement of ESG. We need a common taxonomy to help financial markets rigorously identify environmental outperformance and to direct investment accordingly. The EU’s Green Taxonomy and the Green Bond Standard are good starts, but they are binary (dark green or brown). Mainstreaming sustainable investing will require a richer taxonomy – 50 shades of green. One promising option… is the development of transition indices composed of corporations in high-carbon sectors that have adopted low-carbon strategies. Such approaches are essential for our citizens to make sure their money is invested in line with their values.

As referenced above, a number of countries and regions including China, the EU and the UK have developed (or are developing) taxonomies. These are classification systems that define, ideally using science-based criteria, whether an economic activity can be described as environmentally sustainable. Lending, investment and other financial activities can then be regarded as green (or not) depending on their alignment with the taxonomy. The most significant development in this area was the publication and adoption of the EU Sustainable Finance Taxonomy in 2020,4 explored in more detail in Chapter 3. For now, it is sufficient to understand that the EU Taxonomy lists sustainable economic activities that make a substantial contribution to at least one

An introduction to green and sustainable finance

of the six environmental objectives set out below, without detracting from any of the others: 1 Climate change mitigation 2 Climate change adaptation 3 The sustainable use and protection of water and marine resources 4 The transition to a circular economy 5 Pollution prevention and control 6 The protection and restoration of biodiversity and ecosystems The EU Taxonomy provides a foundation for many of the EU’s activities and policies to promote sustainable finance. It underpins the EU’s Sustainable Finance Disclosure Regulation and Green Bond Standard. For example, it defines what activities and investments can/cannot be defined as or financed by a bond classified as ‘green’. China and the EU are working on a ‘Common Ground’ project to align their respective taxonomies, and it seems likely that, over time, many other countries will align and harmonize their approach with that of the EU, though some differences between definitions may remain – especially in terms of how gas and nuclear power generation are treated. Harmonization would be a very significant step forward in terms of defining what is or is not ‘green’, but, as discussed above, we also need to consider the transition of firms, sectors and economic activities to ‘green’.

Green and sustainable finance and the climate transition We explore the science of climate change, and its impacts, in Chapter 2. In brief, however, the UN Intergovernmental Panel on Climate Change (IPCC) has shown that global greenhouse gas emissions during the decade 2010–2019 were higher than at any previous time in human history, and continue to rise despite efforts to reduce them, although the rate of increase is slowing. Global CO2 emissions would have to peak by 2025 to limit global warming to 1.5°C above pre-industrial levels by 2050, but achieving this seems highly unlikely at present.5 Restricting global warming to below 2°C will require very substantial reductions in fossil fuel use, and the use of negative emissions technologies that remove CO2 from the atmosphere and store it on land, underground and in the oceans. In addressing the causes and impacts of climate change, two key concepts for all finance professionals to understand, and two of the most important environmental objectives identified in the EU Taxonomy introduced above, are climate change mitigation and adaptation. These are defined as follows. Climate change mitigation seeks to address the causes of climate change, and in particular focuses on reducing or eliminating greenhouse gas emissions. In terms

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Green and Sustainable Finance

of green and sustainable finance, investing in renewable energy, clean transport or energy-efficient buildings are all examples of climate change mitigation, as they aim to reduce or eliminate emissions. Similarly, the net-zero transition plans of countries, sectors and firms are also examples of climate change mitigation. Climate change adaptation seeks to address the impacts of climate change, including the impacts of extreme weather events (e.g. floods and droughts), rising sea levels and rising surface temperatures. Adaptation aims to make countries, communities, businesses and individuals more resilient to the effects of global warming. In terms of green finance, investing in flood and sea defences are obvious examples of climate change adaptation, but so are less obvious financial products and services, such as making climate insurance available to smallholders and farmers. It is difficult to obtain accurate figures for the total size of the global green and sustainable finance market, for reasons including the challenge of defining whether financial instruments and investments are genuinely ‘green’, as discussed. Different bodies and organizations track different indicators, making comparisons difficult, but we can say with confidence that green and sustainable finance is growing rapidly. For example: ●●

●●

●●

●●

●●

The Climate Bonds Initiative (CBI) reports that green bond issuance has increased from just over $100 billion in 2015 to nearly $520 billion in 2021, with cumulative green bond issuance now more than $1.5 trillion. The CBI also reports a nearly 350 per cent increase in social and sustainability bonds of various types (see Chapter 7 for more details), from $98 billion in 2019 to nearly $650 billion in 2021.6 According to the Global Sustainable Investment Alliance (GSIA) – using a very broad definition of the term – global sustainable investment in major markets totalled $35.3 trillion in 2020, an increase of 15 per cent over the two-year period since 2018.7 The UNFCCC Standing Committee on Finance (see Chapter 4) reports that global climate finance flows were 16 per cent higher in 2017–2018 than in the previous two-year period (2015–16), reaching an annual average of $775 billion.8 The Climate Policy Initiative (CPI) finds some $632 billion was invested globally in the area of climate finance in 2019/20 (the figure is an average across both years), an increase of nearly $200 billion since the Paris Agreement was signed in 2015.9

Whilst these are substantial amounts, green and sustainable finance still represents a small, but growing, part of finance overall. Cumulative green bond issuance of $1.5 trillion accounts for merely 1.25 per cent of the total global bond market (2021), and annual issuance of $520 billion is just a fraction of the investment estimated to be needed to achieve global climate and other sustainability goals. Estimates of

An introduction to green and sustainable finance

the investment needed to achieve different (and sometimes overlapping) green and broader sustainability objectives vary, but all are substantial, as set out in Table 1.1. Table 1.1  Financing needs to achieve sustainability goals Finance need

Global investment required

Source

To achieve global $6 trillion per year/$90 sustainable development trillion by 2030 and climate objectives

New Climate Economy: Global Commission on the Economy and Climate (2014–18)10

Median estimates to $15 trillion and $30 trillion meet 2°C and 1.5°C Paris respectively Agreement targets

van Vuuren et al (2020)11

For the EU to achieve net zero by 2050

Approximately €28 trillion in clean technologies and techniques

McKinsey (2020)12

For the UK to achieve net zero by 2050

Approximately £50 billion per year

6th Carbon Budget: UK Committee on Climate Change (2020)13

To achieve the UN Sustainable Development Goals (SDGs)

$5 to $7 trillion per year

World Bank (2020)14

To achieve energy transition consistent with 2°C of warming

$1.7 trillion per year between 2020 and 2030–35

IPCC (2018)15

To achieve energy transition consistent with 1.5°C of warming

$2.4 trillion per year between 2020 and 2030–35

IPCC (2018)16

To achieve net zero by 2050

Approximately $5 trillion per year in energy transition investments by 2030

International Energy Agency (2021)17

Throughout this book, we will use the $6 trillion per year/$90 trillion over 15 years estimated by the Global Commission on the Economy and Climate/New Climate Economy above, which seems consistent with the more recent World Bank estimate of $5–$7 trillion per year to achieve the UN SDGs by 2030. The scale of investment required means that public funds alone will not be sufficient. The financial services sector therefore has a key role to play in mobilizing and directing private capital to support the transition to a sustainable, low-carbon world; it is estimated that up to 80 per cent of the funds required will need to come from private sources.

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Green and Sustainable Finance

This is not only a commercial opportunity for the financial services sector, however. By playing an active role in protecting and improving our planet, financial services can do more than profit financially. Our sector can demonstrate our positive social purpose by playing a key role in the transition to net zero and a more sustainable world. By supporting activities, organizations and industries that can mitigate climate change, helping individuals and communities adapt to the effects of climate change and supporting long-term social and sustainable development goals, financial services organizations can help solve some of the world’s, and local communities’, greatest challenges. According to the IPCC this makes economic sense too, as its most recent report (AR6) finds that – with medium confidence – the global economic benefits of limiting global warming to 2°C above pre-industrial levels will exceed the costs of climate change mitigation activities.18 International and national institutions, and financial services firms large and small, have key roles to play in addressing these challenges and supporting the transition to a sustainable, low-carbon world. Individual finance professionals also play a vital role. As we will explore in Chapter 12, change is ultimately led by individuals, and the changes needed to embed and mainstream green and sustainable finance principles and practice within financial services require finance professionals who have the relevant knowledge and skills to be able to develop and deploy products, services and tools that can mobilize capital to support the transition. This book will equip you with the knowledge and tools you need to begin to apply green and sustainable finance principles in your professional practice, thereby playing an active role in the transition to a more sustainable, low-carbon world and creating prosperity for current and future generations. There is still a long way to go before green and sustainable finance achieves the mainstream scale and effectiveness necessary to address our greatest environmental and societal challenges, though. There are still many barriers and challenges to overcome until, in the words of UN Special Envoy (and former Governor of the Bank of England) Mark Carney, ‘every professional financial decision takes climate change into account’.19 Today, banks and investors are still funding environmentally destructive activities that contribute to climate change and cause substantial and long-lasting environmental and social harm. For example: ●●

●●

Speaking to the UK House of Commons Treasury Select Committee in October 2019, Governor of the Bank of England Mark Carney told Committee members that global markets were currently holding portfolios consistent with 3°C to 3.75°C of warming, and possibly more than 4°C of warming.20 The 2022 ‘Banking on Climate Chaos’ report found that bank lending and underwriting to the fossil fuel sector increased each year following the signing of the Paris Agreement in 2015 to $824 billion in 2019, before falling back slightly to $750 billion in 2020, and $742 billion in 2021.21

An introduction to green and sustainable finance ●●

The same report also found that 60 of the largest global banks had provided a total of some $4.6 trillion of fossil fuel financing between 2016 and 2021. Four US banks accounted for approximately 25 per cent of the banking sector’s fossil fuel financing in the six years following the signing of the Paris Agreement.

Some of the discrepancy between commitments and action can be explained by factors such as the length (tenor) of lending and investment agreements, which in the case of power generation and extractive industries can often exceed 10 years. Whilst these may not be renewed, existing financing agreements will usually be honoured. In addition, taking a broader sustainability lens, lenders and investors may be considering the impacts of a rapid withdrawal of funding on jobs and communities. In some cases, though, financial institutions may be guilty of (at best) inadvertent greenwashing, a concept we explore in the next section. Greater disclosure and transparency of environmental and broader sustainability impacts will, as we will see in later units, help avoid such greenwashing in the future. Public disquiet at the environmentally detrimental activities of financial institutions, combined with rising consumer and retail investor demand for sustainable financial products and services has led to a number of high-profile campaigns, including ‘Make My Money Matter’22 (see short case study in Chapter 9) and ‘Stop the Money Pipeline’.23 Such campaigns encourage retail savers and investors to act by, for example, lobbying against certain financial institutions and moving savings, investments and pensions to alternative, more sustainable providers. In the long term, heightened reputational risk may damage financial institutions’ brands and franchises.

QUICK QUESTION To what extent are your savings, investments and pensions invested in a green and sustainable manner? Can you easily find out? To date, the majority of funding and investment in green and sustainable finance has tended to support climate change mitigation projects and activities, rather than adaptation. The UNFCCC’s Fourth (2020) Biennial Assessment,24 which we examine in more detail in Chapter 4, estimates that public mitigation finance is some two to three times greater than adaptation finance. This is supported by the most recent (2020) Multilateral Development Banks’ (MDB) joint report on climate finance,25 which found that 76 per cent of climate finance went towards mitigation and 24 per cent went towards adaption. Whilst there is inevitably some crossover between mitigation and adaptation projects (e.g. new, greener infrastructure may be sited further away from coastlines), and there is a lack of consistent reporting on mitigation versus adaptation, it is clear the latter is currently substantially underfunded.

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Greenwashing The transition to a sustainable, low-carbon world (often referred to as ‘net zero’) requires systemic economic transformations impacting all economic activities and entities, including individuals, businesses and public-sector organizations. Increasing demand for green and sustainable products and services of all kinds creates substantial commercial opportunities for many, including the banking and finance sector. Without common definitions such as those provided by the EU and other taxonomies, as we saw above it is impossible to accurately classify economic activities, and products and services, as ‘green’ and/or ‘sustainable’. This may lead to ‘greenwashing’ (and more broadly ‘purpose-washing’) – a key concept that all finance professionals should be aware of and take active steps to uncover and avoid. For the purposes of this book, we define greenwashing as ‘… inadvertently or deliberately misleading others about the environmental or broader sustainability benefits of an activity, project, product or service’. There are many different types of greenwashing, for instance: ●●

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Making public commitments to climate change and sustainability that are not backed by consistent action and/or are contradicted by an organization’s activities (e.g. where a bank makes public commitments to increasing its green lending, but continues to fund businesses that engage in large-scale deforestation). Overstating the environmental benefits of a product, service or activity (e.g. a hybrid vehicle, or a ‘green bond’ that in fact does little to improve the environment). Highlighting the positive environmental or broader sustainability benefits and impacts of a product or service, whilst failing to mention related detriments. Describing an investment or an investment fund as ‘green’ or ‘sustainable’ when, in fact, only a small part of the fund could be described as such (this is explored in more detail in Chapter 9). Describing an activity, product or service as ‘green’ or ‘sustainable’ without measuring, monitoring and verifying outcomes, so the environmental and sustainability benefits (and/or detriments) are not truly understood. Emphasizing the environmental benefits and impacts of a product, service or activity without disclosing that these would have been achieved in any case (in a similar manner, promoting the issue of green bonds when the same projects would have been financed by a regular bond issuance).

There have been many high-profile cases of greenwashing and purpose-washing, including Volkswagen in Germany 2015, H&M Norway in 2019 and Boohoo in the UK in 2020. We explore the different dimensions of greenwashing and its implications for the finance sector and finance professionals in subsequent chapters. For now,

An introduction to green and sustainable finance

though, it is sufficient to note that it is one of the most significant challenges to mainstreaming green and sustainable finance. If consumers, investors and others cannot be confident that the environmental benefits and impacts of products, services, investments and other activities are genuine, then the integrity of the green and sustainable finance market is brought into question. In April 2020, for example, a study by Schroders found that 6 out of 10 institutional investors across 26 countries identified greenwashing as the greatest deterrent to sustainable investment.26 We consider greenwashing and how it can be avoided and prevented throughout this book and course. In Chapter 9 (Responsible and Sustainable Investment) we will also look at evolving regulations designed to maintain investor confidence and market integrity in the context of detecting and preventing greenwashing.

The dimensions of green finance and sustainable finance The breadth of the terms ‘green finance’ and ‘sustainable finance’ means they can be used to refer to: ●●

financial products and services

●●

organizational strategies and approaches

●●

industry sectors

In this book, we cover all of these, and briefly introduce them here.

Green and sustainable financial products and services Green and sustainable finance covers a wide range of financial products and services. These can be broadly divided into banking, investment, and insurance products and services. Examples of these are explored in more detail in Chapters 6–11 and include, but are by no means limited to: ●●

bonds (such as green bonds, social bonds, sustainability bonds and transition bonds)

●●

green, social and sustainability-linked loans

●●

green/sustainable/ESG stock exchange listings and indices

●●

green/sustainable/ESG investment and pension funds (including index-tracking and exchange-traded funds)

●●

impact underwriting (green and sustainable insurance products and services)

●●

climate risk insurance

●●

green current, deposit and savings accounts

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green and green retrofit mortgages green and sustainable FinTech products and services (e.g. carbon footprint trackers linked to mobile banking apps)

But what makes a financial product ‘green’ and/or ‘sustainable’? In many cases the ‘green’ or ‘sustainable’ aspect of the product relates to the underlying investible asset, such as investments in clean energy projects or reforestation. In other cases, the features of the product are designed to encourage or reward environmentally friendly or other socially beneficial activity. Examples include mortgages that are discounted in line with a property’s energy efficiency, or an investment or loan that links the sustainable management of resources with additional investment, discounted interest rates or lower collateral requirements. Other products, services and activities labelled ‘green’ and/or ‘sustainable’ may not be universally accepted as such, for example: ●●

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financial products (such as credit cards) that offer a donation to a social cause (e.g. a cancer research charity) in reward for a certain level of spending; financial products that respond to an environmental and/or social issue (such as flood insurance) but do not seek to address the causes of this issue (in this case, climate change); green bonds and loans that fund sustainable projects and activities that would have happened anyway using regular bonds and loans; investment funds labelled as ‘green’, ‘sustainable’ or ‘ESG’ when in fact they contain substantial proportions of assets that are harmful to the environment; activities that minimize the environmental impacts of the provider’s operations (such as an investment manager switching to renewable energy for its own building) without addressing the main impacts of its activities (in this case the manager’s investment decisions).

These examples raise the question of where the boundary lies in terms of green and sustainable finance. We explore this in more detail in subsequent chapters. For now, however, note that, from our definition of green finance, the product, service or organization should deliver positive environmental and/or social sustainability impacts, and not cause significant harm. As we saw above, greenwashing – both inadvertent and deliberate – can significantly harm the integrity and development of the growing green and sustainable finance market.

An introduction to green and sustainable finance

Green and sustainable finance as an organizational approach Green and sustainable finance principles can be applied across an entire financial services organization, not just at a product or individual process level. For some such organizations, such as Abundance, Triodos, Ecology Building Society, Naturesave Insurance or Banca Etica, environmental and social sustainability have been central to their strategy, culture and decision making for many years. This is also the case, particularly in terms of social sustainability, for many building societies, credit unions, cooperative banks and insurers, and other (often mutually owned) financial institutions.

QUICK QUESTION Can you think of other examples of financial services firms that have adopted green and/or sustainable finance as an organizational approach?

A growing number of large, mainstream financial institutions are incorporating green and sustainable finance principles into their activities. This trend has been accelerating, particularly since the Paris Climate Agreement was concluded in 2015 and the UN SDGs were launched that same year. In 2020, for example, the UK bank NatWest made tackling climate change one of the three pillars of its new, ‘purpose-led’ strategy.27 ING, the Netherlands-based financial services group, has been climate-neutral since 2007 in terms of its direct emissions, and has committed to reducing its lending to and investment in coal power generation to ‘close to zero’ by 2025. Every client and transaction is assessed, monitored and evaluated against the bank’s Environmental and Social Risk Framework.28 The European Investment Bank (EIB) has committed to aligning all its financing activities with the principles and goals of the Paris Agreement, becoming the first multilateral development bank (MDB) to do so. The launch of the UN Principles for Responsible Banking in 2019 further encouraged financial institutions to incorporate these principles into their strategies and activities, and as of 2022 they have been adopted by more than 270 banks. The Principles for Responsible Banking are similar in many respects to the well-established UN Principles for Responsible Investment, adopted by nearly 4,000 investment firms. These, together with the UN Principles for Sustainable Insurance, are discussed in more detail in later chapters. The establishment of several coalitions of major financial institutions, in particular the UN-convened Net Zero Banking Alliance, Net Zero Asset Owners Alliance and Net Zero Asset Managers Alliance, brought together under the umbrella of the Glasgow Financial Alliance for Net Zero (GFANZ),29 has

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Figure 1.1  The embedded approach to green and sustainable finance Environment Society Economy

Financial system

given further impetus and collective ambition to embedding green and sustainable finance into organizations, and the finance sector overall. This whole-organization approach to green and sustainable finance is rooted in an understanding that the financial system both serves and relies on the economy, which itself serves society and is embedded in the environment. Such an ‘embedded’ approach means that business decisions take into account the wider economy, society and the environment, as well as the financial implications. This mindset can influence every area of a business, from operations and staff recruitment and development to investment strategy, product design and pricing, risk management, marketing and financial management.

CASE STUDY Triodos and sustainable banking30 Triodos Bank is a global pioneer in sustainable banking, using the power of finance to support projects that benefit people and the planet. Its approach is based on the fundamental belief that economic activity can and should have a positive impact on society, the environment and culture. Triodos values people, planet and profit – the ‘triple bottom line’ – and takes all three into account in its strategy, structure, lending and culture.

An introduction to green and sustainable finance

Founded in 1980, Triodos is overseen by a supervisory board and its shares are administered by a separate Foundation, both of which aim to balance the needs of all of Triodos’ stakeholders. It has branches in the Netherlands, UK, Germany, France, Spain and Belgium, and in 2020 had assets under management of €20.3 billion. Triodos finances organizations and sectors that benefit people and planet, and focuses on the environmental, social and cultural sectors. Examples include organic farming, sustainable property and renewable energy, leisure and childcare, and lending to SMEs and social enterprises. As part of the application review process, Triodos applies its own strict social and environmental lending criteria and publishes a full list of all the organizations it lends to, as well as an annual impact report as part of the bank’s statutory annual report. Approximately 20 per cent of Triodos’ lending is also for residential sustainable mortgages. Many of Triodos’ loans are in the environmental sector; by the end of 2020 it was co-financing 561 projects in the sustainable energy sector, contributing to a generating capacity of 5,100 MW of energy – equivalent to the energy needs of nearly 5 million households. Approximately 0.9m tonnes of CO2 equivalent emissions were avoided. Triodos also financed 17,600 sustainable residential and 480 sustainable commercial properties, 30,000 hectares of nature and conservation land, and 600 education projects benefitting some 632,000 individuals. It is important to note that Triodos operates on a commercial basis, and in 2020 reported a net profit of €27.2m. This was a decline from €39m in 2019, but still represented a positive return given the challenges of Covid-19 faced during the year.

Green and sustainable economic activities Many definitions of green and sustainable finance focus on its role in directing investment towards environmentally sustainable economic activities. The EU Taxonomy, introduced above, is an example of a tool designed to establish which sectors are ‘green’ (and, by omission, which are not). Some sectors are more universally accepted as ‘green’ than others, as shown in Figure 1.2.

QUICK QUESTION Which industry (i.e. non-finance) sectors would you currently associate with green and sustainable finance?

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Figure 1.2  Commonly included green technologies Clean energy

Clean coal CCS Low-carbon infrastructure Low-carbon base stations broadband

Efficiency

Large hydropower nuclear Bioenergy, marine

Fossil fuel power efficiency

Advanced materials Wind, solar, geothermal, Green buildings Smart/mini grid small hydropower Iighting Grid integration Industrial energy storage Most commonly efficiency included Metro, BRT, Afforestation Non-diesel trains reforestation

General grid efficiency

Energy and water efficiency Green agriculture Protected areas biodiversity Land

Pollution prevention, recycling

Electric cars, alternative fuel vehicles Logistics Transport

Wastewater treatment Waste systems Water supply Least commonly included Pollution, waste and water

SOURCE  UNEP (2016) Inquiry into the Design of a Sustainable Financial System: Definitions and concepts, https:// www.unep.org/resources/report/design-sustainable-financial-system-netherlands-input-unep-inquiry

Green and sustainable industry sectors Sectors commonly accepted with little controversy as ‘green’ and ‘sustainable’ include renewable energy production, distribution and storage, energy efficiency in domestic and industrial buildings, green transport, recycling, pollution prevention, water conservation and afforestation/reforestation. Sectors that are more contested or infrequently cited include carbon capture and storage (CCS), nuclear energy and fossil fuel efficiency. The development of taxonomies, in particular the EU Sustainable Finance Taxonomy, introduced above and examined in more detail in Chapter 3, is a key step towards a common understanding of which sectors and economic activities can be described as ‘green’ and ‘sustainable’, and which cannot.

An introduction to green and sustainable finance

Table 1.2a  Examples of green and sustainable economic activities Industry sector Description Renewable energy

Renewable energy comes from a source that is not depleted when it is used or is naturally replenished within a human timescale. This includes solar, wind, geothermal, tidal, wave, hydroelectric and biomass power.

Energy distribution

Most energy is distributed through a grid (an interconnected network for transmitting power). Green energy distribution tends to focus on the integration of renewable energy into the main grid, distributed generation, microgrids (running separately from the main grid) and smart grids that detect and react to changes in energy usage.

Energy storage

Renewable energy storage is key to enabling an increase in the take-up and efficiency of renewables, and can include mechanical storage (for example, pumped water), batteries and thermal energy storage.

Emissions reduction and capture

Carbon emission reduction technologies aim to reduce the carbon dioxide produced by energy generation, transport and industrial processes. Emissions capture tends to refer to Carbon Capture and Storage (CCS) – technology to capture emissions produced in electricity generation and industrial processes.

Energy efficiency

Energy efficiency means reducing the amount of energy that is required to provide a product or service, and is often applied to buildings (domestic, commercial and industrial), appliances and vehicles.

Green buildings

Green buildings are designed, built and used in a way that is energy-efficient, minimizes the use of resources and water, encourages biodiversity and provides a healthy indoor environment.

Green transport

Green transport minimizes carbon and other harmful emissions, uses renewable energy, is energy-efficient and supports sustainable communities. The term can refer to public transport systems and infrastructure as well as private vehicles.

Water conservation

Water conservation aims to sustainably manage freshwater resources and prevent water pollution in nearby lakes, rivers and local watersheds.

Pollution control

Pollution control aims to reduce or avoid the release of harmful substances into the environment, including the air, water and soil. Pollution can also be defined by the type of pollutant, including plastic pollution and thermal pollution.

Waste reduction and management

Waste reduction aims to minimize the amount of waste produced by individuals, households and organizations, including through resource efficiency and reuse. Waste management involves the collection, treatment, recycling, reprocessing and disposal of waste. (continued)

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Table 1.2a  (Continued) Industry sector Description Biodiversity and habitat protection

Biodiversity protection aims to preserve the full range of ecosystems, species and gene pools in the environment – the full variety of life on earth. Habitat protection aims to conserve, protect and restore the natural environments which sustain these plants and animals.

Afforestation/ reforestation

Afforestation means the establishment of forests where previously they did not exist, while reforestation means the re-establishment of forests where they previously existed, either through direct planting or natural growth.

Green and sustainable industry sectors have recently expanded to include areas such as meat substitutes, eco-fashion, plastic alternatives and eco-friendly and/or crueltyfree products, targeted at a rapidly growing retail consumer audience. Finance can support these and other green and sustainable sectors in many ways, which we explore in later chapters in this book. Examples include: ●● ●●

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green bond financing for offshore wind farms investment funds specializing in green transport and related infrastructure investments sustainability-linked loans linked to improvements in pollution control and management

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green mortgages which link repayments to home energy efficiency improvements

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climate insurance to support farmers and smallholders

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circular finance to support eco-fashion producers and recyclers

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venture capital to support innovative new ‘meat-free’ products

Green and sustainable finance are growing rapidly, therefore, and there are very significant commercial opportunities for banks, investment funds, insurers and other financial services organizations to support the transition to a sustainable, low-carbon world. As we described above, however, despite growth in recent years, a substantial investment gap remains. The scale of the challenge is beyond that of public finances alone, and a significant and sustained increase in support from the financial services sector is required to achieve the objectives of the Paris Agreement, the UN Sustainable Development Goals and broader sustainability objectives.

An introduction to green and sustainable finance

Table 1.2b  Further examples of green and sustainable economic activities Industry sector

Description

Meat substitutes

Also known as ‘meat analogues’ or ‘meat alternatives’, these are (usually) plant-based foods that taste like meat. Meat and dairy products account for 14.5 per cent of global greenhouse gas emissions. By reducing meat consumption, we reduce these emissions and help to prevent further deforestation.

Eco-fashion

Eco-fashion, also referred to as ‘sustainable’ or ‘ethical’ fashion, combines organic, recycled or natural materials such as bamboo with fair trade practices and low carbon emissions. According to The World Bank, the fashion sector is responsible for 10 per cent of global emissions. It is also one of the leading polluters through waste products being released into rivers, lakes and oceans. From a wider sustainability perspective, it is estimated that some 40 million garment workers (including children) work gruelling 14–16-hour shifts on average in physically taxing conditions.

Plastic alternatives

Plastic alternatives are generally either biodegradable plastics, or are made from recycled plastic. Other materials, e.g. bamboo, are used instead of plastic. This seeks to reduce the 320 million tonnes of plastic produced each year, of which an estimated 8 million tonnes per year or more pollutes the oceans. Much more plastic waste is buried in landfill sites.

Eco-friendly products

Eco-friendly products are everyday items which do not cause damage, or only very limited damage, to the environment. This is due to the way they are manufactured, the materials they contain or the way that the products are consumed. Eco-products are extremely diverse. Examples include: bamboo toothbrushes, recycled paper, metal water flasks, non-toxic cleaning products, beeswax sandwich wraps and Fair Trade clothing.

Cruelty-free products

Household and self-care products which do not employ animal testing as part of their process. Advocates claim that the use of non-toxic chemicals used in cruelty-free products reduces harmful toxins in our atmosphere. Cruelty-free products generally produce fewer carbon emissions and champion other sustainable causes, too.

Sometimes projects may have competing environmental and social impacts, and this can lead to controversial financing decisions. New battery storage technologies, for example, may support the growth of solar or wind energy by providing the means to store and deliver power when weather conditions would not normally allow this, but may require the mining of rare minerals, causing significant environmental damage and social harm. Similarly, the closure of a thermal coal power generation plant may have significant environmental benefits, in terms of reducing greenhouse gas emissions, but at the same time

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create substantial unemployment and related social problems in a town or region heavily dependent on employment from fossil fuel producers and consumers. Finance can also play a role in encouraging and incentivizing firms or industry sectors to decarbonize by divesting, or threatening to divest, from firms or sectors perceived as damaging the environment. A well-known example is Climate Action 100+, a major investor group that seeks to engage greenhouse gas emitters and encourage them to shift their resources to cleaner energy, supporting the Paris Agreement. In 2018, Royal Dutch Shell, at least in part in response to Climate Action 100+ and other groups, agreed to set short- and long-term carbon emissions targets linked to executive remuneration – the first of the large oil companies to do so. Shell aims to reduce its Net Carbon Footprint by approximately 50 per cent by 2050 and by approximately 20 per cent by 2035 as an interim step. Earlier in 2018, Shell had announced that divestment should be considered a ‘material risk’ to its business. Climate Action 100+ currently (March 2022) engages with nearly 170 organizations estimated to account for some 80 per cent of global, industrial greenhouse gas emissions. Divestment does not necessarily have to be justified in terms of environmental benefits alone. As we will see later in this book, the implications of the net zero transition are substantial, and in some cases existential, for the business models of some sectors and firms – and for the financial institutions exposed to these through their lending and investment decisions. Divestment may, therefore, be an important risk management tool to avoid exposure to significant transition risks and stranded assets. Risk management is covered in more detail in Chapter 5, and divestment, and the decarbonization of investment portfolios, is covered in more detail in Chapter 9.

CASE STUDY Ørsted31 Today, Danish company Ørsted is one of the world’s best known and most respected green energy providers. It was named as the world’s ‘most sustainable company’ by Corporate Knights in 2020. Just over a decade ago, however, it was one of Denmark’s major greenhouse gas emitters, with 85 per cent of its business reliant on fossil fuels. The state-owned company, then called DONG Energy (Danish Oil and Natural Gas), was responsible for considerable air pollution too, leaving a literal and metaphorical dark cloud over Copenhagen. DONG Energy set out to change this, setting targets in 2009 to transition their business to 85 per cent green energy and 15 per cent dark (fossil fuel) energy, using green finance to fund the transformation. In 2017, DONG Energy – soon to be Ørsted – entered the green bond market. By Q3 2022, Ørsted had approximately DKK 59.4bn ($8bn) of total green bond issuance. Green bonds account for some 80 per cent of the company’s total bond portfolio, and all long-term bonds issued in the future will be in a green or sustainable format.

An introduction to green and sustainable finance

In addition to reducing their carbon emissions. Ørsted has gained considerable commercial success. The Ørsted transformation can be seen in key metrics. Between 2007 and 2021, carbon emissions decreased 86 per cent. At the same time, their operating profit has more than doubled, and the share of that profit coming from renewables has increased to 90 per cent. Before their transition, Ørsted was largely a domestic supplier, but today they are the leading global operator of offshore windfarms and are building onshore wind, solar and battery storage capacity too. The Ørsted group is now carbon neutral in terms of Scope 1 and 2 emissions, and has a target of net zero across Scope 1, 2 and 3 emissions by 2040. As well as benefiting the environment, Ørsted will profit from the reputational benefits this brings, and avoid the impact of carbon pricing and increasing environmental regulation that may reduce competitors’ returns.

Challenges for green and sustainable finance Our financial system has three key characteristics that can contribute to environmental and other problems of sustainability, rather than offer solutions: ●●

a bias towards short-termism in decision making

●●

a narrow focus on profit and shareholders

●●

a tendency not to address ‘externalities’

QUICK QUESTION Why, do you think, does finance often adopt a short-term perspective?

Short-termism The time horizons in which financial institutions and finance professionals make decisions are often too short to consider the longer-term environmental or social effects of an investment or activity. This short-termism is intensified by the pressure to deliver positive, often quarterly results for shareholders. This can discourage financial institutions from investing in sectors that offer long-term value rather than short-term gain and can encourage them to discount the long-term risks of their activities, which often include environmental risks. Regulatory pressures to enhance liquidity can also dissuade financial institutions from offering products designed to build value over the long term.

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The impacts of short-termism demonstrate the link between time horizons and different types of risk and reward. What might in the short term look productive because of its immediate revenue potential, can in the long term be unproductive and unprofitable because of its negative environmental and social impacts. Short-termism has particularly significant implications for responding to the climate challenge. While the worst impacts of climate change will most likely be felt by future generations, the measures needed to avoid catastrophic climate change and its impact on individuals, communities and the financial system are required urgently. This is known as the ‘Tragedy of the Horizon’.

READING Mark Carney on the ‘Tragedy of the Horizon’32 The challenges currently posed by climate change pale in significance compared with what might come… So why isn’t more being done to address it?... Climate change is the Tragedy of the Horizon. We don’t need an army of actuaries to tell us that the catastrophic impacts of climate change will be felt beyond the traditional horizons of most actors – imposing a cost on future generations that the current generation has no direct incentive to fix. That means beyond: ●●

the business cycle

●●

the political cycle

●●

the horizon of technocratic authorities, like central banks, who are bound by their mandates

The horizon for monetary policy extends out to two to three years. For financial stability it is a bit longer, but typically only to the outer boundaries of the credit cycle – about a decade. In other words, once climate change becomes a defining issue for financial stability, it may already be too late.

In addition, climate policy action, and financing and business decisions taken today to tackle climate change by reducing greenhouse gas emissions, will only have an effect in the longer term. This is because, as we will see in Chapter 2, concentrations of greenhouse gases remain in the atmosphere for a considerable length of time – in many cases 20 years or more. Taking action to decarbonize lending and investment portfolios today will not, therefore, have an impact on concentrations of greenhouse gas emissions in the short term, but is necessary to avoid increasing concentrations and further global warming in the decades to come.

An introduction to green and sustainable finance

A short-term perspective that fails to consider the longer-term implications of climate change and other sustainability factors may also prevent firms, and potentially entire sectors, from making the changes to their business models needed in order to transition to net zero by mid-century. As we will explore in later chapters, the transition may pose an existential threat to some sectors and firms, with failure to adapt and adjust leading to a ‘Kodak’ or ‘Blockbuster’ moment. This, in turn, has significant implications for financial institutions that are highly exposed.

QUICK QUESTION Who are the key stakeholders for your organization?

Narrow focus Since the 1960s and the growth of the ‘Chicago School’ of economics, the main purpose and role of a business has been viewed by many as being to maximize returns to its shareholders. This idea has had a powerful effect on the conduct of business and approaches to the regulation of firms. It has also been a key assumption in many economic models used to inform policy. This view of the role of business, however, does not have a strict basis in company law. This leads some to argue that the purpose of business should be much broader than simply maximizing shareholder return. As economist Julie Nelson elaborates: Case law has established that directors and managers of corporations have a ‘fiduciary duty’ [duty of loyalty of care] to the corporation. This is often interpreted as requiring them to maximize returns to shareholders. Yet, if you look at the actual descriptions of the duties of directors, what you find is a requirement that they must act ‘in a manner… reasonably believed to be in the best interests of the corporation’… [I]t does not specify that the ‘corporation’ is the shareholders only, nor that serving the ‘interests of the corporation’ means maximizing profit… It is my tribe, economists, who are the source of this fixation with maximization… While legislators and judges have… generally been rather vague about the purpose(s) of business, mainstream economists have been vociferous in popularizing the idea that firms have a single, simple, and (conveniently!) quantifiable goal.33

Decisions made by companies, including financial institutions, that narrowly focus on maximizing shareholder returns can lead to damage to the environment and other significant social costs in three main ways: ●●

only financial risk and reward is considered in the decision-making process, while environmental damage and social costs are neglected;

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●●

individuals and communities impacted by the environmental or social consequences of decisions are unlikely to be shareholders, and are not included in decision making; a focus on profit maximization combines with short-termism, and so the impact of environmental damage or social costs on future profits is not considered.

The implications of a profit maximization approach are not always immediately apparent. This is because they are often cumulative, as in the case of water pollution caused by the release of industrial chemicals. Or they may not be immediately visible, as with climate change caused by burning fossil fuels. Industrial accidents and environmental disasters, such as a major oil spillage can, however, bring the dangers of profit maximization to the fore. In 2010, the explosion of the BP Deepwater Horizon drilling rig caused the death of 11 workers as well as substantial short- and longer-term environmental impacts due to the release of oil into marine habitats. BP was fined a record $20.8 billion as a result. More recently, there have been calls for businesses, including financial services, to move to a ‘stakeholder value’ approach. In 2019, for example, the new Statement on the Purpose of a Corporation by the influential US Business Roundtable was published.34 This included obligations to customers, communities, employees and suppliers alongside shareholders. In 2021, the World Economic Forum proposed the adoption of ‘Stakeholder Capitalism’, whose goal of increasing the well-being of people and planet explicitly contrasts with that of short-term profit maximization.35 These developments have been criticized by some, however, for being greenwashing or purpose-washing, due to a perceived lack of action by signatories and endorsers in putting the principles espoused into action. The stakeholder value approach sees the role of business as that of generating value for all of the stakeholders it serves, including customers, employees, suppliers, shareholders and the wider community. Proponents of sustainability argue that future generations should be considered as a key stakeholder group, and this has particularly important implications for longer-term environmental issues such as climate change. A stakeholder value approach has parallels with the ‘embedded’ model of the financial system, in that a financial institution is embedded in society. It therefore serves not only its shareholders, but also a wide range of different actors within and beyond the financial system.

QUICK QUESTION Why might financial decision making not take environmental and other sustainable factors into account?

An introduction to green and sustainable finance

Externalities Externalities are the un-costed, un-priced side effects of economic activities – the impacts of decisions on stakeholders (such as individuals, communities and the environment) who do not have any control over those decisions. Externalities can be both positive and negative, although in the context of climate change and the environment, the great majority of externalities are negative. Imagine a factory that produces waste chemicals that slowly drain into a local stream. Downstream, the water gradually becomes unfit for consumption and uninhabitable for aquatic life. Yet the cost of cleaning up the river does not, in many cases, fall to the factory’s management and shareholders. This is because the factory treats the pollution as an ‘externality’ – something that is ‘external’ to its decision making because the costs are hidden or borne by someone else (in this case, probably, the local community or an environmental agency). Externalities mean that when financial institutions assess the risks and rewards of a lending or investment decision using criteria rooted in maximizing shareholder returns, other factors, including environmental and social costs, are often not considered. This leads to investment in sectors and projects that generate pollution, carbon emissions, habitat destruction and other environmental and social damage because the costs of these are ‘hidden’. They are not borne by the financial institution, and so are not included in the decision-making process. Externalities are linked to a short-term focus (since many environmental and social effects are not apparent in the short term) and profit maximization (since damage that does not directly affect profits is discounted). A failure to consider externalities may also contribute to the risk of investing in assets that may subsequently become substantially impaired or ‘stranded’, as we discuss in Chapter 2. Negative externalities may be addressed through enhanced measurement and quantification of climate-related and other environmental impacts, regulations to prevent the most harmful activities, the introduction of realistic and consistent carbon pricing, carbon and other taxes to fund environmental protection and restoration, and public pressure for companies to internalize the costs of their externalities. As the costs of climate-related and other environmental impacts become increasingly recognized, and priced accordingly, the direct costs of climate change have an increasing impact on financial institutions, which is one reason why identifying, measuring and disclosing climate-related and environmental risks is now a major focus for institutions, policymakers and regulators, as we will see throughout this book.

Opportunities for green and sustainable finance A longer-term, more sustainable approach to finance can help financial institutions, and the financial system overall, to overcome the challenges of short-termism, a narrow

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focus and un-costed externalities. This can lead to a range of positive outcomes for organizations, customers, staff, supply chain and other partners – and our planet. As we will see throughout this book, there are a wide range of benefits for institutions adopting a green and sustainable finance approach, including: ●●

Reputation and relationships: {{

{{

●●

{{

{{

{{ {{

{{

{{ {{

An opportunity to improve competitive position and attract new customers through differentiation. An opportunity to develop and market innovative green and other sustainable products and services. Retention of existing customers and markets. Greater resilience to market disruption caused by climate change, and the costs of social transition. An opportunity to decrease risk across portfolios, by avoiding concentration in areas of high environmental or other risks (such as fossil fuels). Greater resilience to the operational impact of climate change and other social changes. Increased valuation through resilience planning. More efficient operations, including energy efficiency, resource minimization and reuse, reduced water usage and adoption of new technologies.

Regulatory: {{

{{

●●

Access to new markets – including new partnerships with governments and communities.

Operations: {{

●●

Stronger, values-based relationships with governments, communities, customers, investors, partners and suppliers.

Markets: {{

●●

Enhanced reputation and credibility – helping to demonstrate finance’s social purpose and reconnecting banks and society.

Potentially lower capital weightings for ‘green’ and/or ‘sustainable’ assets and higher weightings for ‘brown’ assets. Preparedness for regulatory and policy changes (for example, increased disclosure, stress testing, including climate change scenarios).

Customers: {{

Managing changing customer preferences, leading to new product and service opportunities.

An introduction to green and sustainable finance

{{

{{

●●

Greater satisfaction – the ‘feel-good factor’.

Staff: {{

{{

{{

●●

Longer-term, less transactional relationships with customers based on values rather than price.

Greater ability to attract and retain younger generations who see sustainable values as an important part of their personal and working lives. Greater staff satisfaction and employee engagement from enhanced sense of purpose aligned with individuals’ values. Enhanced working environments.

Partners and supply chains: {{

{{

{{

Increased resilience of the supply chain (less affected by environmental and social issues, such as the use of forced labour). Incentives for partners to enhance the sustainability of their own operations and supply chains. Longer-term relationships with suppliers based on shared purpose and values.

The UN Sustainable Development Goals As we discussed earlier in this chapter, a broader approach to sustainable finance and development encompasses, but goes beyond, ‘green’ finance. It includes issues of economic and social equality and justice too. Economic, social and environmental issues are inextricably linked, and genuine sustainable development (meeting the needs of the present without compromising the ability of future generations to meet their own needs) is impossible without considering these wider aspects. This is the approach to green and sustainable finance we support and promote throughout this book. The UN Sustainable Development Goals (SDGs) are targets for global development defined and adopted by 193 countries in 2015. They are intended to be achieved by 2030. Whilst not legally binding, they encourage governments, business and civil society to address wider issues of economic, environmental and social sustainability. Whilst 17 SDGs have been identified, these are rarely successfully addressed individually. Many are linked; for example gender equality (SDG 5) requires improvements in, among other areas, health (SDG 3), education (SDG 4), inclusive economic growth (SDG 8) and more accountable, inclusive institutions (SDG 16). Successful approaches to working towards the achievement of the SDGs, and the financing of these, therefore requires an understanding of how sustainability goals are linked and interdependent.

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Table 1.3  The UN Sustainable Development Goals The 17 Sustainable Development Goals are: Goal 1

End poverty in all its forms everywhere

Goal 2

End hunger, achieve food security and improved nutrition and promote sustainable agriculture

Goal 3

Ensure healthy lives and promote well-being for all at all ages

Goal 4

Ensure inclusive and equitable quality education and promote lifelong learning opportunities for all

Goal 5

Achieve gender equality and empower all women and girls

Goal 6

Ensure availability and sustainable management of water and sanitation for all

Goal 7

Ensure access to affordable, reliable, sustainable and modern energy for all

Goal 8

Promote sustained, inclusive and sustainable economic growth, full and productive employment and decent work for all

Goal 9

Build resilient infrastructure, promote inclusive and sustainable industrialization and foster innovation

Goal 10

Reduce inequality within and among countries

Goal 11

Make cities and human settlements inclusive, safe, resilient and sustainable

Goal 12

Ensure sustainable consumption and production patterns

Goal 13

Take urgent action to combat climate change and its impacts

Goal 14

Conserve and sustainably use the oceans, seas and marine resources for sustainable development

Goal 15

Protect, restore and promote sustainable use of terrestrial ecosystems, sustainably manage forests, combat desertification, and halt and reverse land degradation and halt biodiversity loss

Goal 16

Promote peaceful and inclusive societies for sustainable development, provide access to justice for all and build effective, accountable and inclusive institutions at all levels

Goal 17

Strengthen the means of implementation and revitalize the global partnership for sustainable development

The 17 SDGs are defined in more detail by 169 Targets, with progress towards these tracked by 232 Indicators to facilitate the measurement of impacts and progress towards achieving the overall goals.36 The online SDG Tracker (https://sdg-tracker.org) is a free, open access tool where progress towards the SDGs can be viewed at global and, in many cases, regional and country level.

An introduction to green and sustainable finance

READING SDG 5 Targets and Indicators37 SDG 5 (Achieve gender equality and empower all women and girls) is supported by 9 Targets and 14 Indicators: ●●

Target 5.1: End discrimination against women and girls ❍❍

●●

Target 5.2: End all violence against and exploitation of women and girls ❍❍

❍❍

●●

❍❍

Indicator 5.3.1: Proportion of women aged 20–24 years who were married or in a union before age 15 and before age 18. Indicator 5.3.2: Proportion of girls and women aged 15–49 years who have undergone female genital mutilation/cutting. Indicator 5.4.1: Proportion of time spent on unpaid domestic and care work, by sex, age and location.

Target 5.5: Ensure full participation in leadership and decision making ❍❍

❍❍ ●●

Indicator 5.2.2: Proportion of women and girls aged 15 years and older subjected to sexual violence by persons other than an intimate partner in the previous 12 months, by age and place of occurrence.

Target 5.4: Value unpaid care and promote shared domestic responsibilities ❍❍

●●

Indicator 5.2.1: Proportion of ever-partnered women and girls aged 15 years and older subjected to physical, sexual or psychological violence by a current or former intimate partner in the previous 12 months, by form of violence and by age.

Target 5.3: Eliminate forced marriages and genital mutilation ❍❍

●●

Indicator 5.1.1: Whether or not legal frameworks are in place to promote, enforce and monitor equality and non-discrimination on the basis of sex.

Indicator 5.5.1: Proportion of seats held by women in (a) national parliaments and (b) local governments. Indicator 5.5.2: Proportion of women in managerial positions.

Target 5.6: Universal access to reproductive rights and health ❍❍

❍❍

Indicator 5.6.1: Proportion of women aged 15–49 years who make their own informed decisions regarding sexual relations, contraceptive use and reproductive health care. Indicator 5.6.2: Number of countries with laws and regulations that guarantee full and equal access to women and men aged 15 years and older to sexual and reproductive health care, information and education.

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●●

Target 5.A: Equal rights to economic resources, property ownership and financial services ❍❍

Indicator 5.A.1: Proportion of total agricultural population with ownership or secure rights over agricultural land, by sex; and (b) share of women among owners or rights-bearers of agricultural land, by type of tenure.

Indicator 5.A.2: Proportion of countries where the legal framework (including customary law) guarantees women’s equal rights to land ownership and/or control. Target 5.B: Promote empowerment of women through technology ❍❍

●●

❍❍ ●●

Indicator 5.B.1: Proportion of individuals who own a mobile telephone, by sex.

Target 5.C: Adopt and strengthen policies and enforceable legislation for gender equality ❍❍

Indicator 5.C.1: Proportion of countries with systems to track and make public allocations for gender equality and women’s empowerment.

Countries, firms, organizations and others are encouraged to take ownership of the Sustainable Development Goals and establish frameworks or other mechanisms for aligning with the SDGs most relevant to their aims, objectives and circumstances. For example: ●●

●●

●●

●●

●●

In Scotland, the new National Performance Framework, published by the Scottish Government in 2018, incorporates the SDGs in a ‘vision for national wellbeing’. In 2019, the ‘Business Avengers’ initiative was launched, which brings together 17 large companies (including Coca-Cola, Google, Mastercard, Nike and Unilever), each chosen to represent one of the 17 SDGs, to promote the ‘decade of delivery’ between 2020 and 2030. The UN Principles for Responsible Banking require signatories to align their strategies, activities and operations with the SDGs (as well as the Paris Agreement). Carlsberg’s ‘Together Towards ZERO’ programme seeks to significantly improve the organization’s sustainability to enhance business performance and reduce impact on the environment and society. Carlsberg focuses its efforts on seven SDGs where it believes it can have the greatest impact: 3, 6, 7, 8, 12, 13 and 17. ANZ (Australia and New Zealand Banking Group Limited) has developed an SDG Bond Framework and will issue bonds where proceeds will contribute to SDGs 3, 4, 6, 7, 9, 11 and 12.

An introduction to green and sustainable finance

QUICK QUESTION Which of the SDGs are most relevant, in your view, for your organization or for an organization you are familiar with?

CASE STUDY Santander UK Sustainability and Responsible Banking Strategy38 In its Environmental, Social and Governance Supplement 2021, Santander UK states: Being a responsible business is a key business priority and part of our core strategy. To understand what this means for the business, we have a Sustainability and Responsible Banking strategy covering our material issues, based on three pillars plus one solid foundation. The bank’s strategy is explicitly linked to the SDGs, as set out below. Pillar 1: Thriving workplace We aim to create a thriving workplace that develops a culture of inclusivity and belonging: ●●

Diversity, inclusion and belonging

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Social mobility

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Employee well-being and talent

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Organizational culture and governance

Contributing to SDGs 3, 5 and 10. Pillar 2: Better communities We want to deliver long-lasting, sustainable growth and positive socio-economic impact: ●●

Financial inclusion

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Community engagement and support

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Sustainable/ESG products

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Inclusive innovation and digitalisation

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Cybersecurity

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Data security and protection

Contributing to SDGs 1, 3, 4, 5, 8, 9, 10, 11, 13.

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Pillar 3: Healthy environment We will play our part in supporting the UK transition to a low-carbon economy and support the green economy: ●●

Managing climate risks

●●

Supporting customers’ transition to a low-carbon economy

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Reducing emissions in our operations

●●

Ensuring a just transition

Contributing to SDGs 7, 13, 17. Foundation We will aim to be responsible in everything we do with ethics and integrity being a solid foundation of our strategy, enabling business and society to prosper: ●●

Ethics and compliance

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Responsible banking practices

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Financial crime

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Human and labour rights

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Responsible supply chain and procurement

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Fair market competition

Contributing to SDGs 1, 4, 5, 8, 10, 12, 14. Four of the SDGs have been identified as ‘core’, which the bank highlights and reports against in more detail: Table 1.4  Four of the SDGs SDG 4 Quality education

Key SDG target (summarized)

Key highlight (2021)

–– Eliminate gender disparities in education and ensure equal access to all levels of education

£9.2m in donations made to university partners

–– Ensure that all youth and a substantial proportion of adults achieve literacy and numeracy skills 8 Decent work and economic growth

–– Take immediate and effective measures to eradicate forced labour, modern slavery, human trafficking and child labour

6,466 vulnerable customer support notes added

–– Expand access to banking, insurance and financial services for all

(continued)

An introduction to green and sustainable finance

Table 1.4  (Continued) SDG

Key SDG target (summarized)

10 Reduced inequalities

–– A fiscal, wage and social protection policies to promote greater equality –– Improve the regulation of global financial markets and institutions

13  Climate action

–– Integrate climate change measures into policies, strategies and planning –– Improve education, awareness and capacity on climate change issues and measures

Key highlight (2021) 86% of colleagues report the bank has the right environment for diversity £3.97bn provided for projects and activities classified as ‘green’

We saw above that the World Bank estimates between $5 and $7 trillion of annual investment is required to achieve the SDGs. As with climate change mitigation and adaptation finance, a key challenge cited by the UN and others is how to mobilize capital to achieve the SDGs, as the majority of the capital required will need to come from the private sector. Achieving and financing the SDGs will also require major shifts in business models, both in financial services institutions and business more broadly, alongside the transition to net zero. This includes a deeper recognition of the investment chain connecting the finance sector with broad issues of sustainability. Financial institutions can support the achievement of the SDGs in many ways, including but not limited to: 1 Aligning their strategies, activities and operations with the SDGs, as encouraged by the Principles for Responsible Investment, Principles for Responsible Banking, and Principles for Sustainable Insurance. 2 Ensuring investment decisions incorporate environmental, social and governance factors, or more preferably, linking desired investment outcomes with the SDGs themselves. 3 Explicitly aligning definitions of fiduciary duty with broad definitions of sustainable development. 4 Engaging with companies they hold a stake in, either individually or as part of a coalition.

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5 Providing debt finance for SDG solutions. 6 Promoting access to finance for individual entrepreneurs and small enterprises seeking to achieve the SDGs. 7 Developing innovative financial products and processes that allow people to invest in line with the SDGs, reduce the costs of doing so and strengthen governance where needed. 8 Ensuring that operations and wider business activities support, rather than detract from, the achievement of the SDGs 9 Encouraging more private investment in SDG-aligned ventures. 10 Divesting from investments that do not support the SDGs. In later chapters we will examine some of the sustainable finance products and services that can support the achievement of the SDGs, including sustainability and SDG bonds, and sustainability-linked loans.

Key concepts In this chapter, we considered: ●●

the various definitions of green and sustainable finance, and the difference between these and related terms;

●●

some of the typical characteristics of approaches to green and sustainable finance;

●●

the challenges and opportunities for green and sustainable finance;

●●

the UN Sustainable Development Goals (SDGs).

Review Sustainable finance encompasses making both the activities and operations of the financial services sector more sustainable, by considering broader economic, environmental and social factors in an organization’s strategy and management; and the financing of sustainable economic, environmental and social objectives. For the purposes of this book, we define ‘sustainable finance’ as ‘The inclusion of economic, environmental and social factors in an organization’s strategy, management, activities and operations, combined with the financing of sustainable economic, environmental and social objectives.’ The signing of the Paris Agreement on Climate Change in 2015 saw many policymakers, regulators and financial services practitioners focus on environmental sustainability, which includes increasing finance for new technologies and activities designed to reduce greenhouse gas emissions (‘climate change mitigation’) and/or to

An introduction to green and sustainable finance

support climate-resilient development (‘climate change adaptation’). It also encompasses identifying and disclosing climate-related financial risks. This has become known as ‘green finance’. In practice it seems difficult, if not impossible, for any genuinely sustainable approach to finance not to incorporate environmental factors, particularly those relating to climate change. Similarly, it is hard to separate the environment from the economy and society, as they impact each other. Green finance and sustainable finance are highly interrelated, with green finance being a major and integral element of sustainable finance overall. This is the approach we adopt throughout this book, in which we generally refer to ‘green and sustainable finance’. For the purposes of this book, we define ‘green finance’ as ‘Any financial initiative, strategy, product or service that is designed to protect the natural environment and support the transition to a sustainable, low-carbon world, and/or to manage climaterelated and other environmental risks impacting finance and investment.’ This is a broad definition which focuses on enhancing and sustaining the natural environment and managing current and future environmental risks. Green and sustainable finance products and services include those that: ●●

channel capital to relevant industry sectors;

●●

reward environmentally friendly and socially purposeful activities; and

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support the effective management of physical and transition risks.

The most commonly cited green and sustainable industry sectors include renewable energy production, distribution and storage, energy efficiency in domestic and industrial buildings, clean transport, recycling, pollution prevention, water conservation, agriculture, aquaculture and forestry. Other sectors include meat alternatives, ecofashion and environmentally friendly household products. Green and sustainable finance can also be a whole-organization approach, driving strategy, culture and business processes throughout a firm. This is often tied to a stakeholder-focused corporate mission and an understanding of the organization as embedded in the economy, society and the environment. At present, however, the financial sector is not ‘green’ and ‘sustainable’ overall. Institutions still provide significant amounts of funding to environmentally destructive activities, including the burning of fossil fuels. There are some significant barriers and challenges to overcome until, in the words of UN Special Envoy Mark Carney, ‘every professional financial decision takes climate change into account’. Our current financial system has three key characteristics that contribute to environmental problems, and other social issues: ●●

a bias towards short-termism in decision making

●●

a narrow focus on profit and shareholders

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a failure to address ‘externalities’

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Supporting the transition to a sustainable, low-carbon world requires very substantial capital. Estimates of the investment needed vary, but figures of $93 trillion overall/$6 trillion per year are plausible. The scale of investment required means that public funds alone will not suffice. The financial services sector has a key role to play in mobilizing and directing private capital to support the transition. It is estimated that up to 80 per cent of the funds required will need to come from private sources. The UN Sustainable Development Goals (SDGs) set out the major economic, environmental and social challenges faced by our world. These go beyond the challenges of climate change mitigation and adaptation and offer a more holistic approach to sustainability, going beyond the boundaries of green finance alone. They provide a widely adopted framework for considering sustainable finance, and an increasing number of financial and other institutions are aligning their strategies and activities with the SDGs. Green and sustainable finance is a growing global phenomenon and represents a significant opportunity for the financial services sector. This is not only a commercial opportunity, but also an opportunity for the sector to demonstrate its social purpose, by playing a key role in the transition to a sustainable, low-carbon world.

Table 1.5  Key terms Term

Definition

Biodiversity

The full range of ecosystems, species and gene pools in the environment – the full variety of plant and animal life on earth.

Climate change adaptation

Projects and activities that aim to improve resilience to the effects of climate change.

Climate change mitigation

Projects and activities that aim to reduce greenhouse gas emissions and the rate of climate change.

De-carbonization

Reducing the amount of carbon (for example, carbon dioxide or methane) emitted from an agricultural, industrial or other process.

Divestment

The opposite of an investment, for example, selling rather than buying an asset such as shares in a firm.

Embedded approach

An approach that sees the financial system as embedded in the economy, society and the environment.

Fossil fuels

Fuel such as coal or oil formed from the decayed remains of plants or animals. (continued)

An introduction to green and sustainable finance

Table 1.5  (Continued) Term

Definition

Green finance

Any financial initiative, strategy, product or service that is designed to protect the natural environment and support the transition to a sustainable, low-carbon world and/or manage climate-related and other environmental risks impacting finance and investment.

Greenwashing

Making false, misleading or unsubstantiated claims about the positive environmental impact of a product, service or activity.

Intergovernmental Panel on Climate Change (IPCC)

The United Nations body that assesses the science related to climate change. The IPCC provides regular assessments of the scientific basis of climate change, its impacts and future risks, and options for adaptation and mitigation.

Just transition

Ensuring that the transition from a high- to low-carbon economy is fair for current and future generations, particularly those communities and workers most impacted.

Net carbon footprint

The total greenhouse gas emissions associated with the production, processing and consumption of products and services, offset by activities to mitigate emissions, such as Carbon Capture and Storage.

Paris Agreement

In December 2015, countries agreed to combat climate change and to accelerate and intensify the actions and investments needed to support the transition to a low-carbon world. The Agreement’s central aim is to strengthen the global response to the threat of climate change by keeping a global temperature rise in the 21st century below 2°C above pre-industrial levels and to pursue greater efforts to limit the temperature increase to 1.5°C. The Agreement entered into force in November 2016 after being ratified by countries accounting in total for at least 55% of total global greenhouse gas emissions.

Renewable energy

Energy that comes from a source that is not depleted when it is used or is naturally replenished within a human timescale.

Stakeholder value approach

An approach that sees the role of business as generating value for all the stakeholders it serves.

Sustainable finance

The inclusion of economic, environmental and social factors in an organization’s strategy, management, activities and operations; combined with the financing of sustainable economic, environmental and social objectives. (continued)

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Table 1.5  (Continued) Term

Definition

Tragedy of the horizon

The mismatch between business, political and regulatory cycles, and the timescale needed to prevent climate change impacting financial stability.

Transition finance

Finance that supports the transition of firms, sectors and economic activities to low-carbon means of production and distribution, aligned with the objectives and timescales of the Paris Agreement.

UN Sustainable Development Goals

17 objectives agreed by 193 countries in 2015 to address the major environmental, social and economic challenges of our time.

UNFCCC

The United Nations Framework Convention on Climate Change. Agreed in 1992 and ratified by 197 parties to the Convention, the UNFCCC is the key international treaty providing a global framework for combating climate change. The Paris Agreement (see above) is an agreement reached within the UNFCCC process.

Notes 1 Brundtland et al (1987) Report of the World Commission on Environment and Development: Our common future, https://sustainabledevelopment.un.org/content/ documents/5987our-common-future.pdf (archived at https://perma.cc/6P6S-XJGK) 2 UNEP (2016) Inquiry into the Design of a Sustainable Financial System: Definitions and concepts, https://www.unep.org/resources/report/design-sustainable-financial-system-neth​ erlands-input-unep-inquiry (archived at https://perma.cc/JYU5-2Z38) 3 Carney, M (2019) Remarks given during the UN Secretary General’s Climate Action Summit 2019, https://www.bankofengland.co.uk/-/media/boe/files/speech/2019/ remarks-given-during-the-un-secretary-generals-climate-actions-summit-2019-markcarney.pdf (archived at https://perma.cc/AER9-JAMR) 4 Europe Commission (2020) EU Taxonomy for Sustainable Activities, https://ec.europa. eu/info/business-economy-euro/banking-and-finance/sustainable-finance/eu-taxonomysustainable-activities_en (archived at https://perma.cc/JJ2V-7M8U) 5 IPCC (2022) Working Group III contribution to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, https://www.ipcc.ch/report/sixth-assess​mentreport-working-group-3/ (archived at https://perma.cc/SU43-WFL5) 6 Jones, L (2022) $500bn Green Insurance 2021: social and sustainable acceleration: Annual green $1tn in sight: Market expansion forecasts for 2022 and 2025, Climate Bonds Initiative, 31 January, https://www.climatebonds.net/2022/01/500bn-green-issu​ ance-2021-social-and-sustainable-acceleration-annual-green-1tn-sight-market (archived at https://perma.cc/6P7J-BFER)

An introduction to green and sustainable finance 7 Global Sustainable Investment Alliance (2021) Global Sustainable Investment Review 2020, http://www.gsi-alliance.org/wp-content/uploads/2021/08/GSIR-20201.pdf (archived at https://perma.cc/4SDS-XGBW) 8 UNFCCC (2021) Fourth (2020) Biennial Assessment and Overview of Climate Finance Flows, https://unfccc.int/sites/default/files/resource/54307_1%20-%20UNFCCC%20 BA%202020%20-%20Summary%20-%20WEB.pdf (archived at https://perma. cc/9T3J-Y8VK) 9 Climate Policy Initiative (2021) Global Landscape of Climate Finance 2021, https:// www.climatepolicyinitiative.org/wp-content/uploads/2021/10/Full-report-GlobalLandscape-of-Climate-Finance-2021.pdf (archived at https://perma.cc/6HQT-LRT4) 10 The New Climate Economy (2018) Unlocking the Inclusive Growth Story of the 21st Century, https://newclimateeconomy.report//2018 (archived at https://perma. cc/9LH5-TE94) 11 van Vuuren, D P et al (2020) The costs of achieving climate targets and the sources of uncertainty, Nature Climate Change 10 12 D’Aprile P et al (2020) Net-Zero Europe, McKinsey and Company, November, https://www.mckinsey.com/~/media/mckinsey/business%20functions/sustainability/ our%20insights/how%20the%20european%20union%20could%20achieve%20 net%20zero%20emissions%20at%20net%20zero%20cost/net-zero-europe-vf.pdf (archived at https://perma.cc/WRX8-A2EL) 13 Committee on Climate Change (2020) The Sixth Carbon Budget, December, https:// www.theccc.org.uk/wp-content/uploads/2020/12/The-Sixth-Carbon-Budget-The-UKspath-to-Net-Zero.pdf (archived at https://perma.cc/HF6A-R4RH) 14 Vorisek, D and Yu, S (2020) Understanding the cost of achieving the sustainable development goals, World Bank Group, February, https://documents1.worldbank.org/curated/ en/744701582827333101/pdf/Understanding-the-Cost-of-Achieving-the-SustainableDevelopment-Goals.pdf (archived at https://perma.cc/A3US-FSDK) 15 IPCC (2018) Global Warming of 1.5°C Special Report, https://www.ipcc.ch/sr15/ (archived at https://perma.cc/G4GJ-HHJB) 16 Ibid. 17 IEA (2021) Net Zero by 2050: A roadmap for the global energy sector, https://www.iea. org/reports/net-zero-by-2050 (archived at https://perma.cc/645A-FDBR) 18 IPCC (2022) Working Group III contribution to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change (p 49), https://www.ipcc.ch/report/sixthassessment-report-working-group-3/ (archived at https://perma.cc/B7K2-V2YT) 19 Carney, M (2020) Building a Private Finance System for Net Zero, COP26, https:// ukcop26.org/wp-content/uploads/2020/11/COP26-Private-Finance-Hub-Strategy_ Nov-2020v4.1.pdf (archived at https://perma.cc/JL8V-DY5E) 20 Partington, R (2019) Bank of England boss says global finance is funding 4C temperature rise, Guardian, https://www.theguardian.com/business/2019/oct/15/bank-ofengland-boss-warns-global-finance-it-is-funding-climate-crisis (archived at https://perma. cc/7CS5-FTX4)

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Green and Sustainable Finance 21 Rainforest Action Network (2022) Banking on Climate Chaos 2022, https://www. bankingonclimatechaos.org//wp-content/themes/bocc-2021/inc/bcc-data-2022/ BOCC_2022_vSPREAD.pdf (archived at https://perma.cc/P2AS-KQ3U) 22 Make My Money Matter (nd) https://makemymoneymatter.co.uk/ (archived at https:// perma.cc/EZU3-SPJ2) 23 Stop The Money Pipeline (nd) Defund Fossil Fuels and Stop Funding Climate Crisis, https://stopthemoneypipeline.com/ (archived at https://perma.cc/XEZ9-EF9X) 24 United Nations (2021) UNFCC Standing Committee on Finance: Fourth (2020) Biennial Assessment and Overview of Climate Finance Flows, https://unfccc.int/sites/default/ files/resource/Fourth_BA_2020_technical_report-V21.pdf (archived at https://perma. cc/8FLJ-YTXH) 25 Multiple Development Banks (2020) 2020 Joint Report on Multilateral Development Banks’ Climate Finance, https://www.ebrd.com/2020-joint-report-on-mdbs-climatefinance (archived at https://perma.cc/VX39-3S44) 26 Schroders (2020) Sustainability: Institutional Investor Study 2020, https://www.schroders. com/en/us/institutional/insights/institutional-investor-study-2020/sustainabil​ity/ (archived at https://perma.cc/6ET2-7V3T) 27 NatWest (2022) Our Purpose, https://www.natwestgroup.com/our-purpose.html (archived at https://perma.cc/F7JP-FDBV) 28 Ing (nd) Climate Action, https://www.ing.com/Sustainability/Sustainability-direction/ Climate-action.htm (archived at https://perma.cc/J659-BFXQ) 29 Glasgow Financial Alliance for Net Zero (nd) COP26 and the Glasgow Financial Alliance for Net Zero (GFANZ), https://racetozero.unfccc.int/wp-content/ uploads/2021/04/GFANZ.pdf (archived at https://perma.cc/M8Q8-UXRN) 30 Tridos (nd) Triodos Bank, https://www.triodos.co.uk/ (archived at https://perma. cc/5KV2-7XQV) 31 Ørsted (2021) Annual Report 2021, https://orstedcdn.azureedge.net/-/media/annual2021/ annual-report-2021.ashx?rev=9d4904ddf4c44594adab627f7e4c62be&hash=69CE31C5 D5935DD0DB46313E3BDEC952 (archived at https://perma.cc/ES6L-68CV) 32 Bank of England (2015) Breaking the Tragedy of the Horizon – climate change and financial stability, https://www.bankofengland.co.uk/-/media/boe/files/speech/2015/ breaking-the-tragedy-of-the-horizon-climate-change-and-financial-stability.pdf?la=en&​ hash=7C67E785651862457D99511147C7424FF5EA0C1A (archived at https://perma. cc/A7E6-K4YY) 33 Nelson, J (2018) Economics for Humans, University of Chicago Press, Chicago, p 123 34 Business Roundtable (2019) Business Roundtable redefines the purpose of a corporation to promote ‘an economy that serves all Americans’, https://www.businessroundtable.org/ business-roundtable-redefines-the-purpose-of-a-corporation-to-promote-an-economythat-serves-all-americans (archived at https://perma.cc/TC4R-TDT5) 35 Schwab, K and Vanham, P (2021) What is the difference between stakeholder capitalism, shareholder capitalism and state capitalism? The Davos Agenda 2021, https://www. weforum.org/agenda/2021/01/what-is-the-difference-between-stakeholder-capitalism-share​ holder-capitalism-and-state-capitalism-davos-agenda-2021/ (archived at https://perma. cc/2P9P-L3W7)

An introduction to green and sustainable finance 36 United Nations (2018) Global indicator framework for the Sustainable Development Goals and targets of the 2030 Agenda for Sustainable Development, https://unstats. un.org/sdgs/indicators/Global%20Indicator%20Framework%20after%20refinement_ Eng.pdf (archived at https://perma.cc/FZ5D-SGKY) 37 Ibid 38 Santander (2021) Environmental, Social and Governance Supplement 2021, United Kingdom, https://www.santander.co.uk/assets/s3fs-public/documents/santander_ esg_2021_interactive.pdf (archived at https://perma.cc/5UN9-Z5K5)

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Climate change and our changing world Introduction Green and sustainable finance professionals do not need to be experts in client science, but they should understand how the climate is changing, the factors that cause climate change and its impacts on people and the planet. This is essential in order to align finance to support climate change mitigation and adaptation, and to identify and manage climate and broader environmental and sustainability risks. The most recent comprehensive assessment of climate science, published by the Intergovernmental Panel on Climate Change (IPCC) in 2021/22, shows that human activities are having unprecedented and irreversible effects on the global climate. Global surface temperatures have already risen 1.1°C since the Industrial Revolution, and have increased more rapidly since 1970 than in any other 50-year period in the past 2,000 years. Temperatures are likely to rise by more than 1.5°C above preindustrial levels by 2040 and by more than 2°C later in the century without dramatic reductions in greenhouse gas emissions in the current decade. The activities of the finance sector have a substantial impact on the environment and society, both directly and indirectly. This is a two-way relationship; the finance sector itself is also affected by environmental and social sustainability factors, especially by climate change. Impacts are both positive and negative. Finance can generate positive financial and sustainability returns for itself and for society by supporting the transition to a sustainable, low-carbon world. A range of negative impacts for financial institutions and society occur where climate and other environmental and sustainability risks lead to increased costs, asset impairment and stranding, and environmental and societal harms. In this chapter, written with the generous help and assistance of climate science experts from the UK Met Office, we examine the science of climate change and its impact on our planet, including the environment, society and the finance sector.

Climate change and our changing world

L E A R N I N G OB J ECTI VES On completion of this chapter, you will be able to: ●●

●●

●●

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Explain the key factors that underpin the science of climate change and global warming. Outline the most recent IPCC (Intergovernmental Panel on Climate Change) assessments of future climate scenarios, and the impacts of climate change on human and natural systems. Describe the risks and opportunities for the finance sector arising from our changing environment. Explain the nature of, and challenges arising from, ‘stranded assets’ and the ‘carbon bubble’. Outline the ways in which the finance sector can support the transition to a sustainable, low-carbon economy.

Our changing planet Our planet is impacted by a wide range of interlinked environmental factors which affect all living things – people, animals and plants. Human activity, particularly since the Industrial Revolution, has caused significant harm, including: ●●

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Climate change – large-scale, long-term shifts in the planet’s weather patterns and average temperatures. Habitat loss – destruction or damage to habitats, which means that they are no longer able to support the species previously sustained. Biodiversity loss – extinction of species at local or global level, leading to a reduction in the variety of plant and animal life. Poor air quality – increasing natural or human-made pollution, making the air unhealthy or toxic for humans, plants and animals. Poor water quality – deterioration in the extent to which water is clean and healthy for human, plant and animal life. Scarcity of fresh water – lack of available water to meet the needs of a particular locality or region. Deforestation – destruction of trees to create clear land for other uses (e.g. agriculture). Soil erosion – wearing away of topsoil (the upper layer of soil, which contains the most nutrient-rich materials).

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Contaminated land – land that contains substances that are hazardous to human, plant and animal life. Contaminated seas – the presence of waste, industrial chemicals, sewage and other materials that harm marine life.

As we will see in this chapter, and throughout this book, the finance sector has a substantial impact on the environment and the world we live in. Many of our lending and investment decisions to date have been destructive, such as financing companies and projects that are heavy users of fossil fuels or that create significant environmental and/or societal damage through deforestation or harmful waste. We saw in Chapter 1 that, following the signing of the Paris Agreement in 2015, bank lending to the fossil fuel sector increased rather than decreased. Like the rest of the world, the finance sector is also directly and indirectly impacted by environmental and social factors, particularly climate change. Many environmental and broader sustainability factors are interconnected. An increase in global temperature, for instance, leads to marginal desert habitats becoming uninhabitable, which may lead to a significant decline in or the complete extinction of one or more species. This process could then have further effects on the food chain. Humans have always had an impact on the environment. But since the Industrial Revolution, and particularly since the mid-20th century, these effects have increased dramatically and have led to some irreversible impacts, as we describe below.

Planetary boundaries The concept of ‘planetary boundaries’, pioneered by the Stockholm Resilience Centre, attempts to define the ‘safe operating space for humanity’. It identifies nine key processes and systems – encompassing atmosphere, land, ocean and life – that ­interact to support and regulate the Earth: 1 stratospheric ozone depletion 2 atmospheric aerosol loading 3 ocean acidification 4 biogeochemical flows (nitrogen and phosphorous) 5 freshwater use 6 land-system change 7 biosphere integrity (formerly ‘loss of biodiversity’) 8 climate change 9 introduction of novel entities (formerly ‘chemical pollution’, and now including the release of radioactive materials)1

Climate change and our changing world

Of the nine planetary boundaries, researchers believe that four of these – climate change, biosphere integrity (due to decreased biodiversity), biogeochemical flows and land system change – have already been exceeded.2 This increases the risk of the Earth departing from the ‘safe operating space’ we are accustomed to.

The effects of climate change The effects of climate change are already visible, and include the following.

Higher temperatures Scientific research shows that the average temperature of the planet’s surface has increased since pre-industrial times, and in particular during the 20th century. Global surface temperatures have risen 1.1°C since the Industrial Revolution, and have risen more rapidly since 1970 than in any 50-year period in the past 2,000 years, according to the International Panel on Climate Change’s (IPCC) Sixth Assessment Report (AR6).3 Global greenhouse gas emissions during the decade 2010–2019 were higher than at any previous time in human history, and despite efforts to reduce these emissions, they continue to rise, although the rate of increase is slowing.4 According to the World Meteorological Organization (WMO), the most recent decade (2011–2020) is the warmest on record. In 2020, the global average surface temperature was 1.2°C above pre-industrial times.5 Sulphate pollution (which reflects sunlight and cools the planet) means warming is approximately 0.5°C lower than would otherwise be the case.

Changes in precipitation There have been observed changes in precipitation, although not all areas have data over long periods. Rainfall has increased in the mid-latitudes of the northern hemisphere since the beginning of the 20th century, with heavy rainfall events becoming more frequent and more intensive, especially over North America. The IPCC predicts that more frequent, heavier falls of rain and snow will become the norm in many parts of the world, and this is likely to lead to more frequent and more severe floods, especially in Africa and Asia. There are also changes between the seasons in different regions; for example, the UK’s summer rainfall is decreasing on average, while winter rainfall is increasing.

Changes in biodiversity and nature The UN’s Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services 2019 assessment finds that biodiversity is declining at a rate unprecedented in human history.6 This is caused by a very wide range of factors including or linked with climate change, such as air and water pollution, deforestation and the destruction of habitats. Some 1 million animal and plant species are threatened with extinction, including more than 40 per cent of amphibians, more than 33 per cent of marine

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mammals and almost 33 per cent of reef-forming corals. According to the WWF, species loss is estimated to be between 1,000 and 10,000 times higher than the natural extinction rate.7 Changes in the climate are also bringing changes in the behaviour of species, such as butterflies appearing earlier in the year and birds ­shifting their migration patterns.

Rising sea levels Since 1900, sea levels have risen by about 20 cm globally on average, the rate of sea-level rise has accelerated in recent decades and sea levels will continue to rise, according to the IPCC.8 Depending on the growth in emissions and the extent of further global warming, the average sea level may rise by between approximately 28 cm and 1 m by 2100, compared with 1995–2014 average levels. More substantial rises cannot be ruled out. Even a relatively small rise of 65 cm by 2100 would flood many coastal cities on a regular basis, according to research from NASA.9

Melting sea ice Arctic sea ice has been declining since the late 1970s, by about 4 per cent or 0.6 million square kilometres (an area about the size of Madagascar) per decade. AR6 finds that in the period 2011–2020, the annual average Arctic sea ice area was the smallest since at least 1850. The Arctic is likely to be almost completely free of sea ice in September at least once before 2050.10

Retreating glaciers Glaciers all over the world (in the Alps, Rockies, Andes, Himalayas, Africa and Alaska) are melting, and the rate of shrinkage has increased in recent decades. The most recent IPCC report notes that this rate of retreat is unprecedented in at least the last 2,000 years.11

Melting ice sheets The Greenland and Antarctic ice sheets, which between them store the majority of the world’s fresh water, are both shrinking at an accelerating rate. Research shows that polar ice caps are now melting six times faster than in the 1990s. According to AR6, the rate of ice sheet loss increased by four times between 1992–1999 and 2010–2019.12 Taken together, retreating ice sheets and glaciers were the main contributors to the rise in average sea levels.

QUICK QUESTION Reflecting on the visible effects of climate change outlined above, how do you think the finance sector has directly or indirectly contributed to them?

Climate change and our changing world

The climate system and anthropogenic climate change Before we begin to understand the science of climate change, we must first be able to differentiate between weather and climate. ●●

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Weather is the term to describe the daily fluctuations in the state of the atmosphere. It is characterized by changes in temperature, wind and precipitation, among other weather elements. Changes can occur rapidly, hour by hour or over a period of several days to a week. Climate refers to the average and spread in weather conditions for a particular area over a period of time. Usually this is over many years – the World Meteorological Organization defines this in terms of a period of 30 years.

There is natural variability in both weather and climate. In this unit, ‘climate change’ refers to systematic changes across the climate system in response to a forcing agent. The forcing agent can be natural, for example, a solar cycle or volcanic eruption. Or it could be the result of human activities such as greenhouse gas emissions from industry or changes in land use. The latter is referred to as anthropogenic climate change; that is, climate change caused by humans and human activities. The Intergovernmental Panel on Climate Change (IPCC) defines climate change as: A change in the state of the climate that can be identified (e.g. by using statistical tests) by changes in the mean and/or the variability of its properties and that persists for an extended period, typically decades or longer.13

READING Extreme Weather Events in 202014 Whilst the world grappled with the Covid-19 pandemic in 2020, a series of extreme weather events led to catastrophic results for millions of people, animals and many ecosystems. A report by Christian Aid lists 10 of the most financially devastating events, the costs of which were estimated to exceed $140 billion. ●●

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Bushfires in Australia In January 2020, bushfires fuelled by high temperatures and extreme drought in Australia led to the deaths of 34 people and more than a billion animals; 65,000 people were forced to leave their homes. The fire, which engulfed more than 18 million hectares, caused damage estimated at $5 billion. Locust storms in East Africa During the first few months of 2020, countries including Eritrea, Ethiopia, Kenya, Somalia and Uganda experienced a devastating invasion of locusts. This followed an unusually wet rainy season, creating ideal conditions for the insects

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to reproduce. Locust swarms attacked vast areas, destroying crops, trees and pastures, at an estimated cost of $8.5 billion. As climate change continues, these vulnerable regions are likely to suffer increased rainfall and flooding, potentially leading to further swarms. ●●

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Windstorms Ciara and Alex in Europe Over the course of 2020, many countries in Europe were hit with fierce storms which caused immense damage. The two most severe were storms Ciara and Alex, costing a combined $5.9 billion of damage. Cyclone Amphan in the Bay of Bengal As the planet warms, annual cyclones in the Bay of Bengal have strengthened. In 2020, at least 128 people were killed by one of the strongest storms on record, Cyclone Amphan. With sustained wind speeds of 270 km/h, the storm caused more than $13 billion of damage across India, Bangladesh, Sri Lanka and Bhutan. Atlantic hurricane season in the United States and Central America Between May and November 2020, the Atlantic hurricane season killed more than 400 people and devasted more than $41 billion worth of homes and property. Despite having contributed minimally to global warming, countries in Central America are some of the most vulnerable to extreme weather effects. Floods in China China is the country with the highest flood risk in the world, with a warming climate contributing to intense downpours of rain. In June 2020, China experienced devastating floods that affected more than 35 million people and caused $32 billion of damage. Floods in India Between June and October 2020, floods in India killed more than 2,000 people. Across the country, the monsoon season brought extreme rainfall, exacerbated by climate change. Damages amounted to more than $10 billion. Floods in Kyushu, Japan July 2020 saw record-breaking rainfall hit the island of Kyushu in Japan. This caused major floods and landslides, and 3.6 million people had to leave their homes. The floods caused 82 deaths, with damage estimated at more than $8.5 billion. Floods in Pakistan Increased rainfall in July and August 2020 brought extreme flooding to Pakistan. This resulted in more than 400 deaths and $1.5 billion of damage. As with many other developing countries, Pakistan has contributed relatively little to climate change, but is suffering from the effects.

Climate change and our changing world

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West Coast Fires, United States Between July and November 2020, dozens of wildfires ripped through more than 8 million acres of land across California, Colorado, Arizona, Washington and Oregon, killing at least 42 people. The direct cost of the fires was estimated at $20 billion, with fumes and smoke indirectly triggering health issues for many more individuals.

QUICK QUESTION To what extent do you think the examples of extreme weather events described in the reading above have been caused by, or the impacts increased by, climate change?

Understanding the climate system The climate system is highly complex and interactive. It comprises five major components: 1 Atmosphere – a layer of mixed gases that circles the globe. This is the most rapidly changing part of the climate system where everyday weather takes place. Global atmospheric circulation consists of three main cells – the Hadley, Ferrel and Polar cells – which provide a natural air-conditioning system, transporting heat from the equator to the poles. 2 Ocean – all the liquid surface and underground water, both fresh and saline, which includes rivers, oceans, lakes, aquifers and seas. Approximately 70 per cent of the Earth’s surface is covered by oceans, which are important for the transport and storage of energy. 3 Cryosphere – those parts of Earth’s surface predominantly covered by snow and ice, which play an important role in the climate system. This is due to their high reflectivity (albedo) of incoming solar radiation. The cryosphere consists of ice sheets, glaciers, sea ice and permafrost. 4 Biosphere – the component in which life occurs (terrestrial and marine), and which plays an essential role in the global carbon cycle, mainly through photosynthetic processes in plants. 5 Lithosphere (land surface) – includes surface vegetation and soils, which play important roles in the flow of air over the surface, the absorption of solar energy and the water cycle. The Sun is the most important natural forcing agent, and the primary driver of the Earth’s climate. To maintain a stable global climate, a balance must exist between incoming solar radiation (shortwave radiation) and outgoing radiation (longwave radiation),

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Figure 2.1  The Earth’s energy balance 107

Reflected solar radiation 107 Wm–2

235

Incoming solar radiation 342 Wm–2

342

Reflected by clouds, aerosol and atmospheric gases 77

Emitted by atmosphere

165

Emitted by clouds 67

Reflected by surface 30

Latent 78 heat

350

24 Thermals

40 Atmospheric window Greenhouse gases

Absorbed by atmosphere

24

168 Absorbed by surface

30

Outgoing longwave radiation 235 Wm–2

390 Surface 78 Evaporadiation transpiration

40

324 Black radiation

324 Absorbed by surface

Climate change and our changing world

which is reflected and emitted out to space. This is known as the Earth’s energy balance, and is represented in Figure 2.1. Humans, comprising just a small part of the biosphere, should not have a substantial effect on the climate – but, as we will see later in this chapter, human activity has become an increasingly significant forcing agent. Over the long term, the incoming solar radiation absorbed by the Earth and the atmosphere is balanced by the same amount of outgoing longwave radiation being released. About half of the incoming solar radiation is absorbed by the Earth’s surface. This energy is transferred to the atmosphere as the air in contact with the surface warms (thermals). This process happens by evapotranspiration and by longwave radiation, which is absorbed by clouds and greenhouse gases. The atmosphere, in turn, radiates longwave energy back to Earth as well as back out to space. A number of other drivers can lead to variations in the mean state and other elements of the climate, such as the ‘El Niño’ event described below. These may occur over a range of timescales – from weeks and months, to decades, centuries or even millennia.

CASE STUDY Natural variability: El Niño Southern Oscillation What is El Niño and La Niña? ‘El Niño’ refers to a change in sea surface temperatures across the Tropical Pacific Ocean, linked to a weakening of the usual easterly trade winds. In a non-El Niño year, strong trade winds blowing from east to west maintain a temperature gradient across the Pacific Ocean, with warmer surface water in the West Pacific (near Indonesia) than in the east (near the coast of South America). This warm surface water provides an ample moisture source for cloud formation and precipitation across the Western Tropical Pacific. During an El Niño event, the trade winds slow, and the warm water in the West Pacific extends east, reducing the temperature gradient. El Niño events are sporadic, taking place every two to seven years, and often peak during December. The El Niño and La Niña cycle causes a redistribution of energy that changes weather patterns across the entire globe, triggering floods in Ecuador, droughts in Indonesia and a migration of fish away from the coast of Peru. El Niño even causes an increase in global average temperature. These events are associated with widespread changes in the climate system that last several months, and can lead to significant human impacts, affecting sectors such as infrastructure, agriculture, health and energy. ENSO – an atmosphere-ocean interaction These episodes alternate in an irregular inter-annual cycle called the ENSO cycle. ‘ENSO’ stands for ‘El Niño Southern Oscillation’, where ‘Southern Oscillation’ is the term for atmospheric pressure changes between the east and west tropical Pacific that accompany both El Niño and La Niña episodes in the ocean.

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The name ‘ENSO’ is a reminder that the close interaction between the atmosphere and the ocean is an essential part of the climate process. While the global climate system contains many processes, ENSO is by far the dominant feature of climate variability on inter-annual timescales. Figure 2.2  NASA satellite imagery showing a side-by-side comparison of Pacific Ocean sea surface height (SSH) anomalies during the 1997–1998 and 2015–2016 El Niño events DEC 4 1997

TOPEX/POS

DEC 3 2015

TOPEX/Poseidon 1997–1998

–180 –120 –60

Jason–2

Jason–2/Jason–3 2015–2016

0 MM

60

120 180

A question often asked about climate change is whether the observed changes in the Earth’s climate are due to human influence, or if they can be explained by natural causes. The answer is that both natural causes and human activities (‘anthropogenic factors’) drive climate change. But the strong scientific consensus is that the latter has had, and continues to have, a significant impact. The IPCC’s most recent assessment of the climate science (AR6, 2021/22) goes further, stating: It is unequivocal that human influence has warmed the atmosphere, ocean and land. Widespread and rapid changes in the atmosphere, ocean, cryosphere and biosphere have occurred. The likely range of total human-caused global surface temperature increase from 1850– 1900 to 2010–2019 is 0.8°C to 1.3°C, with a best estimate of 1.07°C.15

In other words, anthropogenic (human) factors have caused approximately 1.1°C of global warming since the Industrial Revolution. Human factors also increase the scale, speed and environmental and societal impacts of global warming, as we shall see below. Global CO2 emissions would have to peak by 2025 to limit global warming to 1.5°C above pre-industrial levels by 2050; however, achieving this seems highly unlikely at present.16

Climate change and our changing world

The greenhouse effect As we saw above, the primary driver of the Earth’s climate is energy from the Sun. Most of the Sun’s energy that reaches the Earth is reflected back into space. But some is trapped by gases in the atmosphere as it radiates back from the Earth’s surface. This is the ‘Greenhouse Effect’, and it warms the Earth like a blanket, making life on Earth possible by elevating the global mean temperature to about 14°C, which is about 30°C warmer than it otherwise would be. Since the Industrial Revolution, human activity (such as burning fossil fuels and changing land use) has altered the natural balance of these greenhouse gases, pushing up their concentrations in the atmosphere and increasing the greenhouse effect. This has caused a rise in global temperatures and other changes to our climate. As we noted earlier, according to the IPCC, global greenhouse gas emissions during the decade 2010–2019 were higher than at any previous time in human history.17 Despite the signing of the Paris Agreement and other efforts to reduce emissions, they have continued to rise – although at a slower rate than previously: 1.3 per cent per year for the period 2010–2019, compared with 2.1 per cent per year for the previous decade.18 The main, naturally occurring greenhouse gases are: ●●

●●

Carbon dioxide (CO2). Current (2021) atmospheric concentrations of CO2 are nearly 150 per cent of those compared with levels prior to the Industrial Revolution, and reached 413.2 parts per million in 2020, according to the World Meteorological Organization.19 CO2 is the main greenhouse gas responsible for global warming, with an atmospheric lifetime of up to 200 years. It can, in fact, remain in the atmosphere for much longer, but the majority of CO2 is absorbed into the oceans over that period. Ice-cores, which give an insight into CO2 levels over hundreds of thousands of years, show that concentrations today are higher than at any time in the last 800,000 years. CO2 enters the atmosphere largely through the burning of fossil fuels. According to the IPCC, emissions of CO2 reached nearly 60 GtCO2e (gigatonnes) in 2019, although there was a fall in emissions the following year because of the Covid-19 pandemic. The IPCC has medium confidence that global CO2 emissions between 2010–2019 approximate the remaining carbon budget for limiting global warming to 1.5°C above pre-industrial levels, meaning a further decade of emissions at this level would use up the remaining carbon budget well before mid-century.20 Methane (CH4). Methane is a naturally occurring greenhouse gas with an average atmospheric lifetime of 12 years. Concentrations in the atmosphere are now some 260 per cent above pre-industrial levels, according to the World Meteorological Organization,21 and it is the most potent greenhouse gas (in terms of its contribution to global warming) after carbon dioxide, being some 25 times more effective at trapping heat. Man-made methane emissions mainly come from natural gas extraction, with other sources including wetlands, landfill, livestock and

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agricultural practices. Because methane remains in the atmosphere for a relatively short time compared with other greenhouse gases, reducing methane emissions – especially from natural gas and agriculture – is an effective way to quickly limit global warming. It was for this reason that at COP26 in Glasgow in 2021, a global coalition of some 100 countries, led by the United States, pledged to reduce methane emissions by 2030. Cutting global methane emissions by 50 per cent by 2030 is estimated to reduce global warming by some 0.2–0.3°C. ●●

Nitrous oxide (N2O). Nitrous oxides have an average atmospheric lifetime of 120 years. Concentrations in the atmosphere are approximately 120 per cent above preindustrial levels, according to the World Meteorological Organization.22 N2O emissions stem largely from agriculture, soil sources and fossil fuel activities. The photolysis of N2O in the atmosphere could lead to the depletion of stratospheric ozone.

According to the IPCC, methane emissions have grown by 29 per cent and nitrous oxide emissions by 33 per cent since 1990.23 Only about 0.1 per cent of the atmosphere is made up of these greenhouse gases. The rest mainly consists of nitrogen (approximately 78 per cent), oxygen (approximately 21 per cent) and argon (approximately 0.9 per cent). Although scarce in our atmosphere, greenhouse gases have an impact on the Earth’s climate system energy balance by trapping heat in the atmosphere, as illustrated in Figure 2.3. Figure 2.3  The effect of greenhouse gases on the earth’s climate system and energy balance

The Greenhouse Effect Solar radiation powers the climate system.

Some of the infrared radiation passes through the atmosphere but most is absorbed and re-emitted in all directions by greenhouse gas molecules and clouds. The effect of this is to warm the Earth’s surface and the lower atmosphere.

SUN

Some solar radiation is reflected by the Earth and the atmosphere.

ATMOSPHERE EARTH About half the solar radiation is absorbed by the Earth’s surface and warms it.

Infrared radiation is emitted from the Earth’s surface.

Climate change and our changing world

READING Measuring greenhouse gas emissions: Carbon dioxide equivalent (CO2e), global warming potential (GWP) and the GHG Protocol24 The most commonly used measure of greenhouse gas emissions is ‘carbon dioxide equivalent’, abbreviated to CO2e, with reductions in emissions often reported using ‘annual CO2e’. While carbon dioxide is the most common greenhouse gas responsible for global warming, as we have seen above, other greenhouse gases including methane (CH4), nitrous oxide (N2O) and hydrofluorocarbons (HFCs) also have a significant impact. Methane, for instance, is 28 times more effective at trapping heat than carbon dioxide, and nitrous oxide 265 times more effective, making them important contributors to the greenhouse effect. This value for the ‘effectiveness’ of other greenhouse gases is known as the ‘global warming potential (GWP)’, measured over a 100-year timescale, with carbon dioxide given a GWP of 1. Different sources offer different values for the GWP of other greenhouse gases, but the IPCC’s Assessment Reports provide a generally accepted benchmark. In the IPCC’s Fifth Assessment Report (AR5), methane is given a GWP of 28, and nitrous oxide a GWP of 265. In measuring and reporting greenhouse gas emissions, and the impact of activities designed to reduce these, CO2e is used as a common unit of measurement. A given quantity of greenhouse gas emissions can be reported as CO2e by multiplying it by its GWP. For example, if an oil and gas company can reduce leakage in its methane pipeline by 10 tonnes per year, this could be expressed as 280 tonnes annual CO2e (i.e. 10 tonnes CH4 × 28). This allows us to measure increases or reductions in emissions in a common unit, despite the different properties of different greenhouse gases. Many approaches are used for estimating and reporting greenhouse gas emissions avoided and/or reduced. They mainly differ according to the assumptions used in the models (e.g. in estimating emissions avoided, assumptions have to be made regarding the future efficiency of, and emissions from, fossil fuel power stations and other industrial units). It is good practice, therefore, for organizations to publish the methodologies they use to estimate emissions, and where possible to keep their methodologies consistent to facilitate comparison between investments and environmental impacts over time. Global standards for measuring emissions are set by the Greenhouse Gas (GHG) Protocol, established by the World Resources Institute and the World Business

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Council for Sustainable Development.25 Emissions are divided into Scope 1, 2 and 3 emissions, and it is important to understand the differences between these: Scope 1 emissions: all direct greenhouse gas emissions from sources that are owned or controlled by the reporting organization. In a financial services context, this would include emissions from buildings, etc., which for many financial institutions will not be major sources of emissions compared to, for example, factories. Scope 2 emissions: indirect greenhouse gas emissions from the consumption of purchased electricity and power for heating, cooling and similar uses by the reporting organization. Again, in a financial services context, emissions are likely to be limited, at least in comparison with other sectors of the economy that are major users of electricity and power. Scope 3 emissions: other indirect emissions that are the result of activities from assets not owned or controlled by the reporting organization, and which are emitted through the organization’s value chain. For many organizations, including financial services firms, Scope 3 emissions represent the majority of total emissions, including the loans and investments made by financial institutions. Scope 3 emissions are the hardest to measure, however, because they include items such as the transportation of products, the usage of products by consumers, waste disposal and – for financial services firms – emissions from loans and investments. The GHG Protocol, working with UNEP FI and the 2 Degrees Investing Initiative (2°ii), has launched the Portfolio Carbon Initiative, which provides guidance for financial institutions on understanding and measuring emissions from lending and investment activities.

According to Le Quéré et al (2020), the majority of global CO2 emissions are produced by the power generation sector, which accounts for nearly half of all emissions, a reflection of its current dependency on fossil fuels.26 Industry accounts for nearly a quarter of global emissions, with surface transport generating approximately 20 per cent. In 2019, the Guardian reported on a study that found 20 fossil fuel companies were responsible for a third of the world’s entire carbon (CO2 and MH4) emissions since the mid-1960s. The study, conducted by the Climate Accountability Institute, showed that four global energy companies alone – Chevron, Exxon, BP and Shell – were responsible for 10 per cent of all such emissions since 1965.27

Climate change and our changing world

QUICK QUESTION Thinking about the organization you work for, or an organization you are familiar with, what (if anything) has it done/is it doing to reduce its direct or indirect emissions of greenhouse gases?

Observed and projected changes in the climate system The Intergovernmental Panel on Climate Change (IPCC) Created in 1988 by the World Meteorological Organization (WMO) and the United Nations Environment Programme (UNEP), the Intergovernmental Panel on Climate Change (IPCC) provides regular assessments of the scientific basis of climate change. The IPCC’s work includes looking at the causes and consequences of climate change. It also assesses options for mitigating climate change and the potential for adapting to its consequences. The IPCC currently has 195 member countries, with thousands of scientists and experts contributing to IPCC reports. Respected, world-leading scientists assess the thousands of research papers published each year to create a synthesis of our current understanding of climate change and related topics. This consensus approach, which takes in a wide range of views, expertise and research, leads to the IPCC’s reports being widely viewed as highly authoritative. IPCC reports are intended to provide scientific information to governments and other players. They are used to develop evidence-based climate policies, as well as to underpin international climate negotiations. Outputs include Assessment Reports (published at intervals of around five to eight years), and Special Reports on specific subjects related to climate change. Since its formation, the IPCC has completed six full assessment cycles, the most recent being its Sixth Assessment Report (known as AR6) published in 2021/22,28 supplemented by a Special Report on Global Warming of 1.5°C in 2018.29 In August 2021, the IPCC published Climate Change 2021: The Physical Science Basis. Contribution of Working Group I to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change,30 the first part of the report from its sixth assessment cycle, AR6, introduced earlier in this chapter. Climate Change 2021, endorsed by all 195 IPCC members, contains the most up-to-date scientific assessment of climate change and the role of anthropogenic factors. It also presents a range of future scenarios for global warming and climate change. Climate Change 2021 was followed in 2022 by two further Working Group

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Reports: Working Group II – Climate Change 2022: Impacts, Adaptation and Vulnerability,31 and Working Group III – Climate Change 2022: Mitigation of Climate Change.32 The IPCC is clear that human activities are having unprecedented and irreversible effects on the global climate, and on the environment more broadly. This includes rising sea levels, increasing ocean acidification, retreating glaciers and ice sheets, further losses of biodiversity and increasing frequency and severity of extreme weather events including storms, wildfires, heatwaves, floods and droughts. Global CO2 emissions would have to peak by 2025 to limit global warming to 1.5°C above pre-industrial levels by 2050, but achieving this seems highly unlikely at present. Immediate, dramatic and sustained reductions in greenhouse gas emissions are required to prevent further global warming and potentially catastrophic climate change.

Observed and future projected changes in global temperatures The IPCC’s Fifth Assessment Report (AR5), published in 2014, presented four future climate scenarios for the period to 2100, known as Representative Concentration Pathways (RCPs): ●●

●●

●●

A ‘low emissions scenario’, RCP 2.6, featuring significant emissions reductions that aim to limit warming; the scenario assumes that average greenhouse gas emissions peak between 2010–2020 and decline substantially thereafter. Two ‘intermediate scenarios’ – RCP 4.6 and RCP 6 – with emissions in the former peaking around 2040 before declining, and in the latter peaking around 2080. A ‘high emissions scenario’, RCP 8.5, which does not include any explicit efforts to reduce output of greenhouse gases from human activity. In this scenario, emissions continue to rise throughout the century.

The RCPs describe future climate scenarios based on different levels of greenhouse gas emissions and concentrations, setting out projections for average global surface temperatures, sea levels and other climate-related variables. They do not, however, consider the socioeconomic drivers of climate change; to do this, ‘Shared Socioeconomic Pathways’ (SSPs) have been developed.33 These are scenarios that include factors such as economic growth, population and technological development. They are used to develop different scenarios for emissions based on different speeds and scales of climate policy action – i.e. anthropogenic factors that impact climate change. The RCPs and SSPs can be combined in Integrated Assessment Models (IAMs) to develop scenarios including both climate and socioeconomic factors.

Climate change and our changing world

The original SSPs (published in 2016) were numbered 1–5. They ranged from SSP1 (where the world successfully mitigates the impacts of climate change, and a successful transition to a more sustainable, low-carbon world is managed) to SSP5 (where economic growth continues to be powered by fossil fuels). Climate Change 2021 updates the SSPs and presents five new scenarios for average global temperature rises (over pre-industrial levels) for the short, medium and long term, as set out in Table 2.1. SSP1–1.9 and SSP1–2.6 assume low greenhouse gas and CO2 emissions declining to net zero around 2050, with negative CO2 emissions after that. SSP2–4.5 assumes that emissions will remain at approximately current levels until 2050, and is based on countries’ current climate policies and pledges. SSP3–7.0 assumes that emissions will double from current levels by 2100, and SSP5–8.5 that they will double from current levels by 2050. As noted earlier, Climate Change 2021 finds that global average surface temperatures have already risen by approximately 1.1°C (in fact, 1.09°C) since the Industrial Revolution, an increase caused by anthropogenic factors. As also noted, sulphate pollution (which is being removed from the atmosphere because of its effects on health) means warming has been approximately 0.5°C lower than would otherwise be the case. Surface temperatures have risen faster between 1970 and 2020 than in any other 50-year period over the past 2,000 years. They are likely to continue to rise by more than 1.5°C above pre-industrial levels by 2040, and by more than 2°C later in the century (within a wide range of variation, depending on climate policy

Table 2.1  2021 Shared socioeconomic pathways and estimates of global temperature rises 2021–2040 Scenario (from low Best to high estimate emissions) (°C)

2041–2060

2081–2100

Very likely range (°C)

Best estimate (°C)

Very likely Best range estimate (°C) (°C)

Very likely range (°C)

SSP1–1.9

1.5

1.2–1.7

1.6

1.2–2.0 1.4

1.0–1.8

SSP1–2.6

1.5

1.2–1.8

1.7

1.3–2.2 1.8

1.3–2.4

SSP2–4.5

1.5

1.2–1.8

2.0

1.6–2.5 2.7

2.1–3.5

SSP3–7.0

1.5

1.2–1.8

2.1

1.7–2.6 3.6

2.8–4.6

SSP5–8.5

1.6

1.3–1.9

2.4

1.9–3.0 4.4

3.3–5.7

SOURCE  IPCC (2021) Climate Change 2021: The physical science basis – summary for policymakers

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and emissions scenarios – the SSPs, as summarized in Table 2.2). Each of the last four decades has been warmer than the preceding one, and the most recent five years have been the hottest since at least 1850. The IPCC concludes that global surface temperatures will increase until at least mid-century under all the SSPs. Under all scenarios, temperatures will exceed the 1.5°C target, but will fall back below this level in the lowest emissions scenario (SSP1–1.9). On the basis of current emissions levels and countries’ climate action plans (SSP2–4.5), temperatures will increase to 2°C by mid-century, and to 2.7°C by 2100. In the worst-case scenario (SSP5–8.5), global warming could reach 4.4°C above pre-industrial levels by the end of the century. Under all except the two lower scenarios, global warming of 2°C looks likely to be exceeded unless dramatic and sustained reductions in CO2 and other greenhouse gas emissions can be achieved. Extremes of temperature over land are likely to be higher than global mean temperature rises, meaning that some areas of the planet would become uninhabitable. As we have described earlier in this chapter, many parts of the world have already been experiencing increasing numbers of heat waves and heavy precipitation events, intensified by the impacts of human activities. Further warming will lead to more regular and extreme heat waves and droughts in some parts of the world, and periods of extreme temperatures will become more common. In some regions, warming will lead to increased precipitation, with very heavy rainfall or snow causing more frequent and more severe flooding. Previous climate change research has shown that, if global warming exceeds 2°C, the impacts of this – including melting sea ice and the release of methane currently captured in permafrost – could lead to a ‘tipping point’ of more rapid and irreversible climate change, sometimes referred to as ‘Hothouse Earth’. The Stockholm Resilience Centre suggests that this could lead to long-term climate impacts where temperatures are some 4–5°C higher than pre-industrial temperatures, and sea levels some 60 m higher than today – with devastating impacts for humanity.34

Observed and future projected changes in the atmosphere Climate Change 2021 finds that increases in greenhouse gas concentrations in the atmosphere since pre-industrial times are unequivocally caused by human activities. In 2019, annual average concentrations were 410 ppm (parts per million) for carbon dioxide (CO2), 1866 ppb (parts per billion) for methane (CH4) and 332 ppb for nitrous oxide (N2O). To put this into context, the IPCC has high confidence that CO2 concentrations are higher than at any time in at least 2 million years, and very high confidence that CH4 and N2O concentrations are higher than at any time in the last

Climate change and our changing world

800,000 years. As noted above, global CO2 emissions reached their highest ever levels in 2019, according to the IPCC. As we have explained, increasing greenhouse gas concentrations increases the greenhouse effect. This leads to increasing global temperatures and other changes to the climate and environment.

Observed and future projected changes in the oceans Climate Change 2021 finds that the average global ocean temperature has increased by approximately 0.9°C since pre-industrial times. It is virtually certain that the global upper ocean (0–700 m) has warmed since the 1970s, and extremely likely that human influence is the main driver of this. It is also virtually certain that human-caused CO2 emissions are the main driver of the current global acidification of the ocean. Warming oceans cause sea levels to rise as a result of thermal expansion, in which warmer water occupies a greater volume. Fresh water from melting polar ice caps and glaciers also contributes to rising sea levels. Climate Change 2021 shows that average sea levels increased by 20 cm between 1901 and 2018 and that the rate of increase is accelerating. Sea levels have risen faster since 1900 than over any preceding century in at least the last 3,000 years. Anthropogenic factors are the likely cause of this. According to the IPCC, it is virtually certain that sea levels will continue to rise during the 21st century and beyond. The extent to which this happens depends on the emissions scenario, as set out in Table 2.2. Sea level rises above the likely range set out in Table 2.2 cannot be ruled out due to deep uncertainty around the melting of ice sheets. In the longer term, under all scenarios sea levels will continue to rise for centuries to millennia due to continuing Table 2.2  Predicted average sea level rises Global average sea level rise (2100)

Global average sea level rise (2150)

Scenario (from low to high emissions)

Likely range (m)

Likely range (m)

SSP1–1.9

0.28–0.55

0.37–0.86

SSP1–2.6

0.32–0.62

0.46–0.99

SSP2–4.5

0.44–0.76

0.66–1.33

SSP5–8.5

0.63–1.01

0.98–1.88

SOURCE  IPCC (2021) Climate Change 2021: The physical science basis – summary for policymakers

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deep ocean warming and the melting of ice sheets. Over the next 2,000 years, average sea levels are expected to rise by between two and three metres if warming is limited to 1.5°C, two to six metres if limited to 2°C, and 19 to 22 metres with 5°C of warming.

Observed and future projected changes in the cryosphere Global observations of the cryosphere over the last three decades show an overall decline in the total amount of ice over land and sea. Reductions in sea ice lead to further warming. This is because the ice – which reflects much of the incoming radiation from the sun back into space – melts to reveal the less-reflective ocean underneath. The melting of land ice has similar effects, but also contributes to rising sea levels. The Greenland and Antarctica ice sheets have been losing mass, glaciers worldwide continue to shrink, and the extent of Arctic sea ice has decreased. Climate Change 2021 concludes that anthropogenic factors are very likely to be the main cause of shrinking glaciers, the decrease in Arctic Sea ice and the surface melting of the Greenland ice sheet. There is only limited evidence, however, of human influence on the melting of the Antarctic ice sheet. The IPCC finds that in the period 2011–2020, the annual average Arctic sea ice area reached its lowest levels since at least 1850. Almost all of the world’s glaciers have been shrinking since the 1950s, which has not happened in at least the last 2,000 years. Melting ice sheets and glaciers combined contributed more than 40 per cent to the increase in average sea levels in the period 1971–2018, but were the main contributors to the rise in average sea levels during 2006–2018. Much of this seems irreversible. The IPCC finds that glaciers and permafrost will continue melting for decades or centuries under all emissions scenarios. Continued ice loss during the 21st century is virtually certain for the Greenland ice sheet, and likely for the Antarctic ice sheet. Arctic sea ice coverage fluctuates with the seasons, with the maximum extent reached in the winter (February/March) and minimum in the summer (September, at the end of the summer melt). Over the period 1979 to 2010, the extent of Arctic sea ice decreased at a rate estimated to be in a range of 3.5 to 4.1 per cent per decade. According to Climate Change 2021, the Arctic is likely to be free from sea ice in September at least once before 2050 under all five emissions scenarios, with more frequent occurrences for higher emissions scenarios and levels of global warming.

QUICK QUESTION What might be the impact of some of these observed and projected future changes – for example sea level rises – on the city/country/region where you live and work?

Climate change and our changing world

Impacts of climate change on natural systems and society According to the second part of the IPCC’s Sixth Assessment Report (AR6), published in February 2022 by the Working Group on Climate Change Impacts, Adaptation and Vulnerability (referred to as Climate Change 2022), anthropogenic climate change has caused a wide range of environmental and societal harms, including some irreversible impacts as natural and human systems are pushed beyond their ability to adapt. According to Climate Change 2022: ●●

some 3.3 to 3.6 billion people live in circumstances that are highly vulnerable to climate change, including flooding, rising sea levels and food and water shortages;

●●

a high proportion of species are vulnerable to climate change;

●●

human and ecosystem vulnerability are interdependent; and

●●

current unsustainable development patterns are increasing the exposure of ecosystems and people to climate hazards.35

As we noted in the introduction to this chapter, the UN’s Intergovernmental SciencePolicy Platform on Biodiversity and Ecosystem Services 2019 assessment estimates that some 1 million animal and plant species are threatened with extinction. The IPCC’s Special Report on Global Warming of 1.5°C (2018) estimates that a 1.5°C average rise in global temperatures would place 20 to 30 per cent of species at risk of extinction.36 Climate change also impacts human systems and society. Although climate change will affect everyone, many of its effects may be felt disproportionately in the developing world, with the individuals and communities most affected by climate change often being those who are the least responsible for global warming. Oxfam’s Confronting Carbon Inequality report (2020) finds that the wealthiest 10 per cent of the global population are responsible for 52 per cent of greenhouse gas emissions. By contrast, the poorest half of the global population are responsible for only 7 per cent of emissions, but are the most threatened by extreme weather events and other impacts of climate change.37 According to the IPCC’s 2018 Special Report Climate Change 2022, these impacts include, but are not limited to:

Agriculture Agriculture is an important sector in many countries, particularly in the developing world, with many individuals, families and regions heavily reliant on the sector for food and economic growth. Global warming scenarios of 1.5°C or above, particularly higher emissions scenarios, predict an increasing frequency and severity of extreme weather events, and an increasing frequency of drought and heat waves, leading to

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soil and water degradation, reduced crop and livestock yields, and adverse effects on irrigation systems. The production of major crops such as wheat, rice and maize in both tropical and temperate regions is expected to be significantly impacted, although some select locations may benefit. Climate Change 2022 finds that economic damage from climate change has already been experienced by the agricultural, forestry and fishery sectors in those regions most affected by the current impacts of climate change.

Aquaculture Aquaculture is another important sector in the developing world. Oceans and marine life are already experiencing large-scale changes at a warming of 1°C, with increased ocean acidification, and critical thresholds are expected to be reached at 1.5°C and above. Coral reefs, which are already in substantial decline, are projected to decline by a further 70–90 per cent at this level. With global warming of 2°C, virtually all coral reefs will be lost. It is estimated that approximately half a billion people rely on fish from coral reefs as their main source of protein.

Biodiversity As already noted, global warming means that many land-based, freshwater, coastal and marine ecosystems are likely to suffer from a continued and significant loss of biodiversity. Climate Change 2022 notes substantial, and in some cases irreversible, damage to ecosystems caused by anthropogenic climate change, exacerbated by other factors including pollution, unsustainable land use and overconsumption. Further global warming will increase the rate of biodiversity loss, potentially by as much as 10 times if temperatures rise from 1.5°C to 3°C above pre-industrial levels. The nearterm risks for biodiversity loss are moderate to high in forest ecosystems and kelp and seagrass ecosystems, and high to very high in Arctic sea-ice and terrestrial ecosystems. A loss of biodiversity will impact many other natural and human systems, including agriculture and aquaculture, food security, and animal and human health and habitation.

Access to water Nearly 2 billion people live in regions of the world where clean, fresh water is scarce, and it is expected this number will increase to nearly 3 billion by 2025. Climate change may significantly reduce access to fresh water due to the increased frequency of droughts and the drying up/silting of lakes and other bodies of fresh water. In addition, in some parts of the world, such as the Himalayas, melting glaciers may have a significant impact – not just on the availability of fresh water, but more widely. Himalayan glaciers and snowmelt supply water to 10 of the world’s most important

Climate change and our changing world

river systems, including the Ganges, Indus, Yellow, Mekong and Irrawaddy, and directly or indirectly supply nearly 2 billion people with water, food and hydroelectric energy, as well as clean air and incomes. In the short term, an increased frequency of extreme weather events could cause severe flooding and disrupt agriculture, homes and livelihoods. In the longer term, if the glaciers were to continue to reduce in size or even disappear, an important source for these major river systems would be disrupted, reducing access to water for drinking, agriculture and power downstream. Climate Change 2022 finds that with 2°C of global warming, the availability of water for agriculture, hydropower and human settlements in the mid- to long term will diminish, with impacts projected to double with 4°C of global warming.

Displacement and migration The IPCC estimates that by 2050, up to 150 million individuals may seek to migrate due to the effects of climate change on the areas, countries and regions where they currently live. This will be caused by a combination of extreme weather events, such as: ●●

flooding

●●

drought

●●

●●

rising sea levels – in both the developing and developed worlds, large numbers of people live near the coast increasing land temperatures, causing parts of the world to become uninhabitable

Climate Change 2022 finds that rising sea levels will continue to impact coastal communities and infrastructure, with some coastal settlements and ecosystems vulnerable to submergence and loss. More than 1 billion people are at increased risk from the impacts of rising sea levels. Some low-lying island nations, including the Maldives and the Seychelles, are particularly at risk from climate change. Rising sea levels may cause significant, long-term flooding and contaminate freshwater aquifers, potentially making the islands uninhabitable. Research by Climate Central38 finds that by 2100 the homes of 200 million people could be permanently underwater. This risk is most concentrated in Asia, particularly in China, Bangladesh, India, Vietnam, Indonesia and Thailand. In many cases, the individuals and communities who bear the least responsibility for causing climate change face the greatest impact.

Health Global warming can have a direct impact on health due to heat waves and other extreme weather events. It can also have an indirect impact on mortality rates, for example through reduced crop and livestock yields, reduced access to clean water,

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sewage overflows and increases in the rates of transmission of infectious diseases. Vector-borne diseases such as malaria, spread by mosquitoes and other insects, are anticipated to become more prevalent and widespread as global temperatures increase. Climate Change 2022 finds that global warming and its impacts have indeed adversely affected the physical health of populations globally, and the mental health of people in those regions most impacted by climate change. The impacts include mortality from extreme heat events, and an increased incidence of food-borne, waterborne and vector-borne diseases. Higher temperatures, increased rain and flooding have increased the incidence of diseases such as cholera and other gastrointestinal infections.

Property and infrastructure Rising sea levels will have a very significant impact on coastal communities in both the developing and developed worlds, affecting poor smallholders in the former and wealthy property owners, investors and tenants in the latter. In Florida alone, for example, it is estimated, in high emissions scenarios, that more than 10 per cent of homes might become uninhabitable by 2100 due to flooding, creating an economic loss of more than $400 billion. The US National Oceanic and Atmospheric Administration predicts that Miami, a very low-lying city, will flood every year by 2070. This will affect not only homes, but airports, businesses, logistics hubs, power stations, transport networks and many other aspects of critical infrastructure. The increased frequency and severity of extreme weather events will impact property and infrastructure in other ways; for example, buildings will need to be constructed, retrofitted or repaired to withstand higher-impact storms, heavier rainfall and other types of extreme weather. Both construction and insurance costs will need to increase in response.

Security Climate change can have a significant impact on many important aspects of human systems and society, including access to food and water, health and property. When such necessities of human society are threatened and communities must compete for scarce resources, conflicts can arise or be exacerbated within or between nations and regions. This may be particularly significant when climate change also leads to substantial displacement and migration within or between countries and regions. Vulnerability to food insecurity increases in many countries as our world warms. The IPCC estimates that nearly 75 per cent of countries will become more vulnerable if global warming increases by 2°C rather than 1.5°C. Many of the impacts of climate change on human systems and society are interlinked, as illustrated by the following case study.

Climate change and our changing world

CASE STUDY Food security and climate change in Sudan39 Food security is intricately linked to climate. In Sudan, agriculture accounts for around one-third of the country’s GDP and employs around 80 per cent of the labour force. Climate change could have a large impact on agricultural production and livelihoods in Sudan, and the World Food Programme and the Met Office undertook a study on the relationship between long-term climate change and future food security. Sudan lies at the northernmost extent of the band of tropical rains known as the Inter-tropical Convergence Zone. This means it has a strong gradient of rainfall, ranging from extremely dry conditions in the north to relatively wet conditions in the south. The climate is hot throughout the year, but with seasonal rains, which can vary from year to year. The large differences in rainfall across the country mean there is a wide variety of livelihoods and agricultural production systems corresponding to the climate in different regions. Pastoral farming dominates in the north, where rainfall totals are low and the onset of the rains is unreliable; cropping systems are more prevalent in the south, where the rainy season is reliably longer and heavier. However, agriculture is mostly rain-fed in Sudan, and is therefore sensitive to rainfall amounts and timings everywhere. This means that climate variability and change are key factors in the future of Sudan’s economy, livelihoods and food security. The study analysed climate model projections for the 2040s. The climate change projections for Sudan indicate a substantial warming trend across the country. In contrast, rainfall projections are mixed, with most models projecting small increases in annual rainfall and some projecting small decreases. However, increased evaporation because of higher temperatures will have a negative impact on water availability. Three scenarios that span the range of available plausible future climates for Sudan were studied. All the scenarios showed varying extents of increased heat and water stress, and year-to-year variability in timings and amounts of rainfall. This will make food production more challenging and increase stresses on livelihoods and food security. The study recommends that adaptation measures should focus on reducing sensitivity, improving resilience to variability and extremes, and improving heat tolerance and water efficiency in agricultural production.

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Responding to climate change As we saw in Chapter 1, responses to climate change take two main forms: ●●

Adaptation (responding to the impacts of climate change)

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Mitigation (preventing or reducing the harm caused by climate change)

Climate change adaptation aims to reduce vulnerability to actual or expected climate change and its effects. According to the IPCC: ‘In human systems, adaptation seeks to moderate or avoid harm or exploit beneficial opportunities. In natural systems, human intervention may help to facilitate the adjustment to change.’40 A very wide range of potential adaptation measures exist, including improving coastal and flood defences, building more climate-resilient infrastructure and property, developing crops and livestock better able to cope with higher temperatures and more generally enhancing communities’ resilience to the impacts of climate change. For example, storms Dennis and Ciara cost insurers in the UK more than £360 million in 2020, with much of this due to flood damage. In March 2020, the UK Treasury announced that funding for flood defences would be doubled to £5.2 billion over the next five years in England alone – accounting for 1 per cent of overall spending on infrastructure. The European Union also makes significant payments to member states in response to, and to build resilience to, similar natural disasters. In 2020, for example, the European Commission granted €56.7 million in aid to Spain. This followed severe flooding in September 2019 which impacted Valencia, Murcia, Castilla-La Mancha and Andalucía. This was part of a wider €279 million aid package to help Portugal, Spain, Italy and Austria deal with major flooding in 2019, and to reduce the impact of future events. As we will see in later chapters, green and sustainable finance can play an important role in climate adaptation, in several ways. At the macro level, major adaptation projects such as flood defences can be funded via green bonds or other investment mechanisms. Loans and other forms of finance may support adaptation enhancements for existing buildings and infrastructure. At the micro level, climate insurance can help increase the resilience of communities and businesses to the effects of climate change. To date, however, the focus of green and sustainable finance has tended to be more on climate change mitigation than adaptation, although this is now beginning to change.

QUICK QUESTION How might the community you live in, or a community you are familiar with, need to adapt to climate change?

Climate change and our changing world

Climate change mitigation refers to active efforts made to reduce or prevent the emission of greenhouse gases, which may be achieved by reducing the sources of these emissions (e.g. by reducing the burning of fossil fuels such as coal, gas and oil) and/or by increasing the carbon ‘sinks’ that can trap and store greenhouse gases (e.g. forests). Mitigation covers a very wide range of activities, from efforts as simple as walking or cycling to work instead of driving, to using new clean technologies and renewable energy and to comprehensive planning for a new, carbon-neutral city. According to the IPCC (2022), with medium confidence, the global economic benefits of limiting global warming to 2°C above pre-industrial levels will exceed the costs of climate change mitigation activities.41 Key global initiatives to reduce greenhouse gas emissions and mitigate the effects of climate change include: ●●

●●

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The United Nations Framework Convention on Climate Change (UNFCCC) An international environmental treaty, which came into force in 1994 with the aim of stabilizing greenhouse gas concentrations in the atmosphere. The parties to the convention (which has a near-universal membership of nation states) have met annually since 1995 at the Conference of the Parties (COP) to assess progress in meeting the UNFCCC’s objectives. Two landmark achievements of the UNFCCC are the 1997 Kyoto Protocol and the 2015 Paris Agreement, introduced briefly below and examined in more detail in the next chapter. The Kyoto Protocol The 1997 Kyoto Protocol committed developed country parties to binding emissions reduction targets. This recognizes that the developed countries are principally responsible for the current high levels of greenhouse gas emissions in the atmosphere, as a result of more than 150 years of industrial activity. The Paris Agreement Adopted at COP 21 (The 21st Conference of the Parties of the United Nations) in Paris in December 2015, the Agreement is the first universal, legally binding global climate agreement. This includes agreement on the long-term goal of keeping the increase in the global average temperature to well below 2°C above pre-industrial levels, and to strive to limit the increase to 1.5°C. Countries’ plans to achieve their climate goals, aligned with the overall objectives of limiting the rise in global warming, are set out in their Nationally Determined Contributions (NDCs).

To successfully mitigate the effects of climate change, significant and sustained reductions in emissions need to be made immediately to keep global warming below 2°C, and as close as possible to 1.5°C. The longer countries, businesses and individuals delay in reducing emissions, the more rapidly we will need to reduce

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emissions in the future to limit global warming. Some nations are already implementing rapid reductions; the UK, for example, had, as of 2018, reduced total greenhouse gas emissions by some 45 per cent since 1993, with a year-on-year reduction between 2017 and 2018 of 2 per cent.42 Rapid emissions reductions can occur when power generation dependent on fossil fuels is replaced by renewables; once this and other ‘easy wins’ are achieved, it becomes more challenging to make further reductions. It is estimated that global emissions fell by approximately 7 per cent in 2020 due to the effects of the Covid-19 pandemic. Overall, however, global annual emissions of CO2 are at best stabilizing, rather than falling. Given the need for rapid cuts in greenhouse gas emissions to meet the target of limiting global warming to 1.5°C above pre-industrial levels, it will be challenging, if not impossible, to achieve this by seeking to reduce CO2 emissions alone. Many pathways to meet this target suggest we may need to actively remove carbon from the atmosphere to enable us to reduce greenhouse gas emissions at a slower pace than would otherwise be necessary. This means that additional mitigation strategies also need to be considered, including the following.

Carbon capture and storage There are many approaches being developed for removing CO2 and other greenhouse gases from the atmosphere, and sequestrating (storing) them; they are commonly referred to as Carbon Capture and Storage (CCS) and/or Carbon Capture Utilization and Storage (CCUS). In CCS, CO2 is captured – usually from emissions at source – liquified and then ‘stored’ underground in geological formations, for example in former oil and gas reservoirs, deep underground or under the sea. In CCUS, CO2 is utilized in areas including food and drink production, and the production of urea, used for fertilizers. According to the International Energy Agency, investment in CCS/CCUS facilities has been accelerating since 2017, mainly in the US and Europe. When completed, global CO2 capture capacity will increase threefold, to approximately 130 million tonnes of CO2 captured and stored/utilized per year.43 This needs to be seen, though, in the context of total global emissions – estimated at 34 billion tonnes of CO2 in 2020, according to the Carbon Disclosure Project.44 Very substantial upscaling of CCS and CCUS technologies is required, therefore, to have a significant impact on atmospheric CO2 levels.

Natural climate solutions Conservation, restoration and management of natural resources, including forests and oceans, and soil carbon sequestration could help limit warming by storing carbon.

Climate change and our changing world

Research shows, however, that the effectiveness of forests and other natural ‘carbon sinks’ (processes that absorb and store carbon dioxide) depends on our future global emissions. In negative emissions scenarios, natural carbon sinks become less effective because there is less CO2 available in the atmosphere to absorb. This could partially offset the intended outcomes of negative emission strategies. While natural climate solutions have a positive effect and are cost-efficient, very large amounts of land would be needed to make a significant impact, potentially putting strain on other areas such as food production.

Methane mitigation Methane comes from the fossil fuel industry and agriculture, as well as other manmade sources. It has a much shorter lifespan in the atmosphere than CO2, but is a much more potent greenhouse gas. Methane’s atmospheric chemistry also leads to more tropospheric ozone, which contributes further to global warming as it reduces the uptake of CO2 by plants and is also harmful to human health. Methane emissions may be reduced by a variety of means, including: ●●

improving agricultural practices

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reducing methane leaks and flaring from oil and gas production and processing

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reducing the combustion of urban waste

Reducing methane emissions would significantly increase the feasibility of limiting global warming to 1.5°C, while also having additional benefits for human health and the ecosystem.

QUICK QUESTION What active steps could you take, as an individual, to mitigate the impact of climate change? What active steps could the organization you work for, or another organization you are familiar with, take?

Climate change and the finance sector An introduction to climate-related financial risks The finance sector has a substantial impact on the environment and the world we live in. This is both directly through the operations of banks, investment firms,

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insurers and other financial services firms, and indirectly through investment choices. Financial services firms may choose to finance unsustainable high-carbon activities, such as the extraction of hydrocarbons, as has been the case in the past, and/or they may choose more sustainable, low-carbon activities, such as renewable energy and clean transport. The choices made by the financial services sector will play a major role in shaping the environment, and our economies and societies, in the years to come. The finance sector is also impacted by changes in the environment, particularly from the effects of climate change. This not only creates significant risks, but also offers substantial opportunities. Key risks include those of asset impairment and stranded assets, while opportunities arise from supporting companies’ and communities’ transitions to a sustainable, low-carbon world, and investing in climate-positive, climate-resilient and other sustainable assets. We will explore the nature of, and the finance sector’s response to, climate-related and broader environmental and sustainability risks in detail in Chapter 5. A basic understanding of these risks is important at this stage, however, to shape our discussion of green and sustainable finance more broadly.

QUICK QUESTION How might a climate-driven natural disaster affect your organization? Think about the full range of stakeholders and how they would be affected.

The risks posed by a changing climate affect the financial system, both directly and indirectly. A climate-related natural disaster, for example, may lead directly to losses for insurers, as we discuss in more detail in Chapter 10. The disaster might result either in more individuals and businesses taking out such insurance to protect against future events, or in a reduction in insurance in affected areas (especially if premiums become more expensive), as well as impairing property values. Many losses from natural disasters may not be insured, especially in developing countries, and this could have a significant adverse impact on the local economy. More widely, changing social norms concerning the environment and/or a disorderly market response could trigger further economic impacts. In 2006, the economist Nicholas Stern released a 700-page review assessing the economic risks of climate change on the UK. Stern estimated that taking a ‘business

Climate change and our changing world

as usual’ approach (without further action to mitigate climate change) would lead to a reduction of at least 5 per cent in GDP, which could increase to 20 per cent or more. Stern argued that the costs of early action on climate change were far outweighed by these potential negative impacts, which he compared to the effect of 20th-century world wars: The evidence shows that ignoring climate change will eventually damage economic growth. Our actions over the coming few decades could create risks of major disruption to economic and social activity, later in this century and in the next, on a scale similar to those associated with the great wars and the economic depression of the first half of the 20th century. And it will be difficult or impossible to reverse these changes. Tackling climate change is the pro-growth strategy for the longer term, and it can be done in a way that does not cap the aspirations for growth of rich or poor countries. The earlier effective action is taken, the less costly it will be.45

In 2015, the Economist Intelligence Unit estimated that the negative impact of climate change on global assets under management to the year 2100 would be between $4.2 trillion and $43 trillion at 2015 prices.46 Given the many variables, the interdependencies between them and the range of possible climate change scenarios, it is impossible to predict impacts with accuracy. It is clear, however, that climate change poses a major threat to the global economy and global growth. Swiss Re, a major global insurance firm and institutional investor, estimates that global GDP will decline by approximately 10 per cent by 2050 if net zero targets for that date are not met.47 Swiss Re’s study also looked at the impact of climate risks on 48 countries representing the great majority of global economic activity. Whilst climate change will impact all countries, economies in Asia are particularly vulnerable to both the physical risks and transition risks of climate change. In general, Europe and the United States are the least exposed. Swiss Re have also developed an easy-to-use interactive map48 which can be used to investigate the impacts of climate change on the countries in their study in more depth. The risks climate change poses to the financial sector – and to all economic sectors and society as a whole – can be classified in three ways: ●●

●●

Physical risks arising from the direct impacts of climate-related hazards to human and natural systems, such as droughts, floods and storms. Transition risks arising from the transition to a lower-carbon economy, such as developments in climate policy, new disruptive technologies or shifting investor sentiment – these can lead to significant losses in economic value due to stranded assets.

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Liability risks arising from parties who have suffered loss or damage from the effects of climate change and who seek compensation from those they hold responsible.

QUICK QUESTION What might be some of the physical, transition and liability risks faced by a financial institution?

The Task Force on Climate-Related Financial Disclosures (TCFD) identified several types of risk within the physical and transition risk categories (the TCFD groups liability risks as a sub-set of transition risks). We look at these, and at the TCFD itself, in more detail in Chapter 5, but a basic understanding of these at this point is helpful. While the risks from climate change can be categorized, and such risks can be predicted and priced at least to some extent, it is important to note that climate risks are complex, interrelated, dynamic and uncertain, which means that the impacts of climate change can crystallize in surprising ways and at scales larger than expected. In addition, it is important to note that climate risks are cross-cutting risks (also known as ‘transverse’ risks), meaning that they impact on the many other types of risk faced by financial institutions, including but not limited to credit, conduct, market, operational, regulatory, reputational and underwriting risks. This is covered in more detail in Chapter 5. Table 2.3  Physical risks Risk type

Examples of risks

Examples of financial impacts

Acute

Increased severity of extreme weather events such ascyclones and floods

Reduced revenue from decreased production capacity (for example, transport difficulties, supply chain interruptions)

Chronic

Changes in precipitation patterns and extreme variability in weather patterns

Increased capital costs (for example, damage to facilities)

Rising sea levels

Cost of replacing assets in high-risk locations and/or increased insurance premiums and potential for reduced availability of insurance

Climate change and our changing world

Table 2.4  Transition and liability risks Risk type

Examples of risks

Policy and legal Increased pricing of greenhouse gas emissions

Technology

Market

Reputation

Examples of financial impacts Increased operating costs

Exposure to litigation

Increased costs and/or reduced demand for products and services resulting from fines and judgments (in extremis, certain products and services may be banned)

Substitution of existing products and services with lower-emissions options

Write-offs and early retirement of existing assets

Costs to transition to lower emissions technology

Costs to adopt/deploy new practices and processes

Changing customer behaviour

Reduced demand for goods and services due to shift in consumer preferences

Changing market valuations

Re-pricing of assets (e.g. fossil fuel reserves, land valuations, securities valuations)

Stigmatization of high-carbon sectors

Lower revenues and higher costs from a combination of reduced customer demand and negative impacts on workforce management and planning (e.g. employee attraction and retention)

Increased stakeholder concern over investing in high-carbon sectors

Reduction in capital availability

Stranded assets and the carbon bubble If global warming is to be restricted to 1.5°C or below, this will require very substantial reductions in the amount of fossil fuels we can continue using for power generation and other production and distribution processes. Current highcarbon business models and systems will need to be replaced by alternative, clean and renewable energy sources, raw materials and processes. Today, the current pace of the transition to a more sustainable, low-carbon world is much slower than required to limit global warming to even 2°C above pre-industrial levels, as envisaged by the Paris Agreement, let alone 1.5°C. As we saw already, the IPCC’s Climate Change 2021 report requires dramatic and sustained reductions

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in greenhouse gas emissions – mostly in the current decade – to limit global warming to those levels. This seems unlikely at present, but the general direction of international and national policy is clear, and we should anticipate a substantial substitution of alternatives for coal, oil, gas and similar high-carbon fuel sources over time. This means that many fossil fuel assets may become impaired or ‘stranded assets’, that is, assets that have suffered from unanticipated or premature write-downs, devaluations or conversion to liabilities. Oil and gas companies, and their investors, for example, currently place high valuations, linked to current market prices, on their key asset – their oil and gas reserves. The demand for oil and gas may fall, however, due to factors including: ●●

the availability of clean and renewable alternatives;

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the introduction of realistic carbon pricing;

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regulatory changes which significantly increase the cost of fossil fuels;

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changing consumer preferences, not just for oil, gas and their derivatives, but for goods manufactured from them/using them, and travel and transport.

At some point, it may cost more to extract, refine and distribute oil and gas than can be recouped from their extraction and sale. Assets (oil and gas reserves) will have become impaired, or stranded. This is sometimes referred to as the ‘carbon bubble’ – the current overvaluation of fossil fuel companies that does not reflect the risk of their assets becoming stranded. In 2017, Mark Carney, then Chair of the Financial Stability Board, stated that a carbon budget consistent with the Paris Agreement’s original 2°C target would leave the ‘vast majority’ of oil, gas and coal stranded. In May 2021, the International Energy Agency’s (IEA) ‘Net Zero by 2050’ scenario posited that, to maintain global warming below 1.5°C by mid-century, the majority of current oil and gas reserves would need to remain unexploited, with no new oil and gas fields being developed and no coal mines opened or extended – the implication being that substantial fossil fuel assets would need to remain in the ground and would become stranded.49 Similarly, Carbon Tracker estimates that the decarbonization of global energy supplies will result in a fall in revenue for the 40 main oil-producing countries, in the amount of $9 trillion by 2040, impacting states mainly in the Middle East, North and West Africa and South America.50 The concept of stranded assets has become prominent in green and sustainable finance as policymakers, regulators, asset owners and investors consider how and

Climate change and our changing world

at what speed the transition to a more sustainable, low-carbon world may strand assets in different sectors. The extent and speed of the transition could have a very significant impact across financial markets; financial services firms are major investors in, and lenders to, a wide range of sectors with a heavy dependency on fossil fuels. This includes not just the coal oil and gas sectors, but also others such as vehicle manufacturers, airlines and petrochemicals, all of which depend on fossil fuels. Firms and sectors that do not rapidly reinvent their business models may face a ‘Kodak’ or ‘Blockbuster’ moment, facing an existential threat to their economic survival. Banks and investors are highly exposed too, through lending, investments, pensions and more. Organizations such as Make My Money Matter (see Chapter 1, and the short case study in Chapter 9) seek to bring this issue to the fore, making both the environmental and financial case for divesting from fossil fuel assets. As we will see in later chapters, central banks and financial regulators believe that a rapid transition to a low-carbon world has the potential to disrupt financial stability. They are thus at the forefront of efforts (such as the TCFD) to identify, disclose and mitigate the effects of stranded assets and of climate-related financial risks generally. There is, therefore, not just a strong environmental case for divesting from the fossil fuel sector, but also a compelling economic one too, based on the current overvaluation and significant stranded asset risk. As we will see in Chapter 9, major institutional investors, led by bodies and organizations such as the PRI and Climate Action 100+, are engaging with large oil and gas companies to recognize, quantify and disclose environmental and stranded asset risks, and to encourage them to shift resources to clean and renewable energy on moral and economic grounds. Some Scandinavian pension funds have withdrawn from all fossil fuel investments, justifying the decision on environmental grounds and to protect investors’ wealth from long-term transition risks.51 Sustainability, then, when considering stranded assets and the carbon bubble, refers to both the environmental and economic sustainability of investments.

QUICK QUESTION How much of your pension and other investments is invested in fossil fuels and other high-carbon assets? Do you know? Is it easy to find out?

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Supporting the transition to a sustainable, low-carbon economy Financial institutions, and the finance sector overall, can take advantage of the opportunities provided to support the transition to a more sustainable, low-carbon world – to a ‘green economy’. This is defined by the United Nations Environment Programme (UNEP) as: ‘One that results in improved human well-being and social equity, while significantly reducing environmental risks and ecological scarcities… it is low-carbon, resource-efficient, and socially inclusive.’52 Just as with green and sustainable finance, there is no single, universal definition of a ‘green economy’, however. Most definitions share some similar features: ●●

economic growth linked to reductions in carbon emissions, resource use and pollution;

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protection of biodiversity and ecosystems;

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greater resilience to natural and financial shocks;

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a financial system which values natural resources; and

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a more inclusive and socially just distribution of resources.

As we saw in Chapter 1, the cost of the transition to achieve the objectives of the Paris Agreement is estimated at $6 trillion per year, with some 80 per cent of investment required from the private sector. It will also require significant legal and regulatory changes, together with continuing changes in social attitudes. Potentially, it could also require new criteria for measuring sustainable economic growth that go beyond the current measures of Gross Domestic Product (GDP) to incorporate wider environmental and social criteria. The UN Sustainable Development Goals, introduced in the previous chapter, could provide the basis for such a framework.

The Green Deal and ‘Building Back Better’ Governments and others have been trying to develop greener approaches to economic growth in recent years, accelerated since 2020 by the Covid-19 pandemic and the economic challenges – and opportunities – created by it. Two of the most prominent examples are the European Union’s ‘European Green Deal’, summarized in the reading below, and a number of initiatives to ‘Build Back Better’, as described in the following case study.

Climate change and our changing world

READING The European Green Deal To build a more sustainable future, the EU has created an action plan, known as the European Green Deal. This aims to transform EU Member States’ economies so that: ●●

there are no net emissions of greenhouse gases by 2050;

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economic growth is decoupled from resource use;

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no person and no place is left behind.

An important part of this plan is to tackle the issue of climate change. Reducing carbon emissions is essential. Using a series of incentives, recommendations and regulations, the EU will look to implement the following: ●●

investing in environmentally friendly technologies;

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supporting industry to innovate;

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rolling out cleaner, cheaper and healthier forms of private and public transport;

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decarbonizing the energy sector;

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ensuring buildings are more energy-efficient;

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working with international partners to improve global environmental standards.

The implementation of the European Green Deal will create opportunities and challenges for financial services firms and finance professionals. The transition of a wide range of economic activities to net zero emissions will create substantial investment opportunities for banks and other institutions; businesses will also need finance – and advice – to support their own transitions. Financial institutions will also need to consider the transition risks facing the investments in their portfolios, as well as the costs of complying with increasing policy and regulatory requirements relating to emissions reduction, including the introduction of more realistic carbon pricing.

CASE STUDY Build Back Better53 The phrase ‘Build Back Better’ is not a new one. It was first coined by former US President Bill Clinton in response to the 2006 Indian Ocean Tsunami disaster. Since

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then, it’s been used many times, but most prominently to refer to recovering from the Covid-19 pandemic in ways that support environmental and social sustainability; greater resilience to health, natural and economic shocks; and a more socially just distribution of the proceeds of economic growth. In the UK, a movement called ‘Build Back Better’ has been established, supported by several NGOs and campaign groups including Friends of the Earth, Greenpeace and the New Economics Foundation. It is a campaign that seeks to overturn the ‘old’ way of doing things and put ethical and sustainable practices first. Proponents campaign for the current economic model of free market capitalism to be consigned to the history books in favour of prioritizing sustainable prosperity – although it should be noted that many of the campaigners’ demands would require substantial financing from private as well as public sources. Demands include: 1 Securing the health and other social needs of current and future generations 2 Protecting and investing in public services 3 Rebuilding society with a transformative Green New Deal 4 Investing in people 5 Building solidarity and community across borders ‘Build Back Better’ members include teachers, healthcare workers, students and others campaigning for change. The group’s steering committee consists of organizations including Green New Deal UK, Medact, Greenpeace, the Public and Commercial Services Union, the UK School Climate Network and Friends of the Earth. It is backed by more than 84 local and international organizations. Separately, the UK Government has established the ‘Build Back Better Council’ to develop plans for a fairer and greener Britain post Covid-19. Members of the Council include representatives of a number of major emitters, including BP, Land Rover, British Airways and Heathrow Airport. The Council is unlikely, therefore, to have credibility in the eyes of campaigning groups such as ‘Build Back Better’. Whether campaign group or government advisory body, it is clear there is a common desire to ‘build back better’. The means and ends may be disputed, but the direction of travel seems clear.

Green growth versus no growth The Green New Deal and similar visions for a greener, more sustainable economy described above either implicitly or explicitly accept the idea that the economy

Climate change and our changing world

must continue to grow, as measured by GDP. Major organizations, including the OECD and World Bank, also see the green economy in terms of growth: OECD: Green Growth means fostering economic growth and development, while ensuring that natural assets continue to provide the resources and environmental services on which our well-being relies.54 World Bank: Growth that is efficient in its use of natural resources, clean in that it minimizes pollution and environmental impacts, and resilient in that it accounts for natural hazards and the role of environmental management and natural capital in preventing physical disasters.55

Supporters of ‘green growth’ tend to rely on the concept of decoupling. This is the idea that we can increase wealth without using more resources or increasing negative environmental and social impacts. Those who advocate decoupling suggest that it can be achieved by means of technology, process and resource innovation, and efficiency. This could be achieved, for example, through the widespread adoption of renewable energy or improved approaches to water use and conservation. This is not a universally accepted perspective, however. Some economists and environmentalists argue that we cannot grow infinitely on a finite planet, and that there are limits to economic growth. Their arguments take a number of forms: ●●

●●

●●

●●

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Relative vs. absolute decoupling – even if we can reduce the resources used per unit of economic output (relative decoupling), increasing levels of output may still require increases in the overall levels of resources used. What is needed is absolute decoupling – an overall decline in resources used. For this to happen, resource use must decrease at least as fast as overall output increases, and must continue to do so as the economy grows. Cost-shifting – what appears to be decoupling may actually be the shifting of costs onto developing nations, for example by moving carbon-intensive production overseas. Limits to efficiency – we cannot improve the efficiency of specific technologies (for example solar or wind power) infinitely. Rebound effect – when a new resource-saving technology is introduced, people tend to change the way they use that technology, which may offset or even outweigh efficiency savings. Consumption paradigm – technology innovation is not sufficient by itself to change our consumption-based culture; we need to shift our whole economic paradigm away from a resource-intensive accumulation and consumption approach.

Instead, it is argued, countries need to move to ‘steady-state’ or ‘post-growth’ economies, in which production and consumption do not continue to grow but remain within

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safe limits. Moreover, because we are already overstretching the Earth’s resources to sustain our current level of economic output, some argue that we first need to enter a phase of de-growth. This consists of a planned, socially just economic contraction to bring us back within our planetary boundaries. Advocates for ‘de-growth’ argue that a simpler, less consumerist way of life would bring greater well-being and equality. They may advocate a shorter working week and an emphasis on non-material pursuits. Steady state or no-growth approaches, if implemented, would have very significant impacts on financial services firms and the finance sector. Overall, future asset and investment values would fall (although some values within this would rise). In a manner similar to the carbon bubble example discussed above, but on a system-wide basis, assets would be impaired and/or stranded, with significant impacts on investments and loan portfolios, and on financial stability overall.

The circular economy One approach to developing a more resilient and sustainable ‘green’ economy that can overcome some of the criticisms of ‘green growth’ is the ‘circular economy’. In contrast to a traditional ‘linear’ economy (make–use–dispose), in a circular economy the value of products and the materials used to manufacture them is maintained for as long as possible. Waste and resource use are minimized. Resources are kept in use for as long as possible, reused, repaired or recycled, and then brought back into use. A ‘product as a service’ approach is a common feature of many circular economies. Rather than replacing mobile phones every two years, for example, a circular economy approach would focus on repairing, restoring and upgrading mobile phones. Friends of the Earth and Zero Waste Europe identify four key principles of a circular economy that aims to achieve high resource efficiency, zero waste and zero emissions:56 1 Efficient material management from extraction to waste – reduce the resources used through product design requirements (to improve performance, phase out hazardous materials, incentivize the repair and reuse of products, and ensure the use of recycled and recyclable materials) and a credible waste policy (with zero landfill and zero incineration). 2 Reduction of toxic substances – regulate to ensure that toxic chemicals are avoided at the design stage and do not hinder recycling and reuse. 3 Energy efficiency – preserve the energy embedded in products and materials and prevent them from becoming waste. 4 Economic incentives – ensure that maximizing resource efficiency and keeping materials circulating in the economy is cheaper and simpler than using new resources – through policy, regulation and taxation.

Climate change and our changing world

According to a McKinsey/Ellen MacArthur Foundation study conducted in 2015, adopting a circular economy approach could create net economic benefit to Europe of €1.8 trillion by 2030, and increase Europe’s resource productivity by 3 per cent.57

CASE STUDY Rapanui58 Rapanui is a sustainable clothing brand that takes the circular model to heart. Each step of its journey is carefully thought out to improve its social and environmental impact on the world: ●●

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Organic farming. The journey starts with sourcing the cotton. Rapanui strategically bases its cotton fields in the North of India. Here, the heavy rainfall in monsoon season significantly reduces the amount of extra water needed to make the cotton grow. Instead of using chemical pesticides, Rapanui makes use of a natural one – cow dung. This encourages local biodiversity and avoids harmful chemical hazards for animals and communities. Interestingly, this secret ingredient is also what makes the cotton so famously soft. Processing. As the cotton is processed, wasted seeds are spun into cakes, which is sold as cow feed. Vegetable oil is squeezed out from the remainder of the petals and seeds, to be used in food products. Sustainable dyeing. Ninety-five per cent of the water Rapanui use for dying the cotton is recovered and recirculated. They use reverse osmosis and distillation to ensure that the water is clean enough to drink. This dramatically reduces water pollution. Excess lumps of colour are dried out and used for road markings. Making products. By spinning, dyeing, weaving, cutting and sewing in the same factory, known as vertical integration, Rapanui save on travel costs and emissions. This also makes compliance and health and safety much easier. The factory is also powered by renewable energy, saving significantly on carbon emissions. Rapanui have two such factories, one in India and one in the UK. The UK factory is powered from its own solar farm, and the Indian factory is run from its own wind farm. Recycling. Rapanui encourages customers to send their clothes back once they are no longer needed, and offers incentives to do this. From the UK factory, they are recycled into new clothes and sold again. Their clothes are designed to be made, remade and remade again, over and over.

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QUICK QUESTION What might be the challenges for Rapanui’s business model?

In 2014, a group of financial services firms, supported by the Ellen MacArthur Foundation, established the FinanCE Working Group to investigate the circular economy model and its implications and opportunities for financial services firms and the sector overall. A definition of circular economy finance was developed: Circular Economy Finance is any type of instrument where the investments will be exclusively applied to finance or re-finance, in part or in full, new and/or existing eligible companies or projects in the circular economy.59

In the Working Group’s view, financial institutions have major roles to play in supporting the transition from the linear to the circular economy. The latter requires the development of many innovative business models that will require different types of traditional and non-traditional finance. In 2016, FinanCE published Money Makes the World Go Round,60 exploring the role of finance in supporting the circular economy, highlighting the need for financial institutions to better identify and price risk from linear economy models, and for the development of new forms of subscription revenue securitization, reverse factoring and collaborative supply chain financing to support circular business models. In 2018, the FinanCE Working Group published a set of voluntary process guidelines with the aim of promoting circular economy finance, bringing consistency to approaches, and enhancing integrity in the circular economy finance market. The Circular Economy Finance Guidelines61 can be applied both to debt and equity products, and are similar in approach to the more established Green Bond and Green Loan Principles, which we introduce in later units. In 2021, UNEP FI published Guidance on Resource Efficiency and Circular Economy Target Setting, a more comprehensive guide for banks seeking to support the circular economy, and for their customers and clients working to increase the sustainable use of natural resources and eliminate pollution and waste.62

Key concepts In this chapter, we considered: ●● ●●

the basic science of climate change and global warming; the most recent IPCC assessments of future climate scenarios, and the impacts of climate change on human and natural systems;

Climate change and our changing world ●● ●●

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our changing environment and the risks and opportunities for the finance sector; the nature of ‘stranded assets’ and the ‘carbon bubble’, and the challenges these present; how the finance sector can support the transition to a sustainable, low-carbon economy.

Review Our planet is impacted by a wide range of environmental and social factors. These are caused and/or accelerated by human activities, and include climate change, habitat loss, biodiversity loss, poor air and water quality, water shortage, deforestation, soil erosion and contamination of the land and seas. Many of these are interconnected. Humans have always had an impact on the environment, but since the Industrial Revolution, and particularly since the mid-20th century, that impact has increased dramatically. An assessment of our ‘planetary boundaries’ – the safe limits for human life – shows that we are already exceeding the safe limits in some key areas, including climate change. Global climate is influenced by five major, interacting components: atmosphere, ocean, cryosphere, biosphere and lithosphere. The sun is the most important natural forcing agent, and the primary driver of the Earth’s climate. Most of the sun’s energy that reaches Earth is reflected back into space, but some is trapped by gases in the atmosphere as it radiates back from the Earth’s surface – this is known as the ‘Greenhouse Effect’. This warms the Earth like a blanket. Human activities (‘anthropogenic factors’), such as burning fossil fuels, increase the concentrations of greenhouse gases – including carbon dioxide, methane and nitrous oxide, leading to increasing global temperatures. Both natural causes and anthropogenic factors drive climate change, but the strong scientific consensus is that the latter has had, and continues to have, a significant impact. The most recent comprehensive assessment of climate science, published by the International Panel on Climate Change (IPCC) in 2021, shows that human activities are having unprecedented and irreversible effects on the global climate. Global surface temperatures have already risen 1.1°C since the Industrial Revolution. Under all scenarios, they are likely to rise by more than 1.5°C above pre-industrial levels by 2040 and by more than 2°C later in the century without dramatic reductions in greenhouse gas emissions in the current decade. Under the highest emissions scenario, global warming could reach 1.9°C by 2040, and 5.7°C by 2100. If global warming exceeds 2°C, factors such as melting sea ice and the release of methane currently captured in permafrost could lead to a tipping point of rapid and ­irreversible climate change.

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Climate change adaptation aims to reduce vulnerability to the effects of climate change on the environment and society. Climate change mitigation aims to reduce or prevent the emission of greenhouse gases, and thereby limit global warming. Key global initiatives to reduce greenhouse gas emissions and mitigate the effects of climate change include: the United Nations Framework Convention on Climate Change (UNFCCC), the Kyoto Protocol (1997) and the Paris Agreement (2015). Green and sustainable finance has a major role to play in supporting both climate adaptation and mitigation activities. The finance sector has a substantial impact on the environment and the world we live in. This is both directly through the operations of banks, investment firms, insurers and other financial services firms, and indirectly through the sector’s lending and investment decisions. This is a two-way relationship; the sector itself is also affected by environmental and social sustainability factors, especially by climate change. These create both significant risks and substantial opportunities. Key risks include those of asset impairment and stranded assets; opportunities flow from supporting companies’ and communities’ transitions to a sustainable, low-carbon world. Estimates of the economic impacts of failing to address climate change vary, but all are substantial. Climate-related financial risks are divided into physical risks, transition risks and liability risks (examined in detail in Chapter 5). One of the most significant transition risks is stranded asset risk – the risk of substantial or total loss of economic value in an asset due to an abrupt change to a low-carbon world. The magnitude of the potential impacts of stranded assets is such that regulators consider an abrupt transition as a systemic threat to the stability of the financial sector. This is not a theoretical issue; in order to limit global warming to 1.5°C most current oil and gas reserves would need to remain unexploited, and all new coal, oil and gas exploration projects would have to cease. Governments and others have sought to develop new approaches to ‘greener’ economic growth in recent years. These have been accelerated by the Covid-19 pandemic and the economic challenges – and opportunities – it created. The finance sector can support and take advantage of opportunities to support greener growth by aligning its activities with initiatives such as the EU’s Green Deal, and by developing new forms of finance that can support the transition from a linear to a circular economy. Many approaches to ‘green’ growth assume continuing economic growth, but some economists and environmentalists do not believe this is possible. They argue that we need to move to a ‘steady-state’ or ‘post-growth’ economy in which GDP remains within safe limits. This would have a very significant impact on financial services and financial stability overall.

Climate change and our changing world

Table 2.5  Key terms Term

Definition

Anthropogenic climate change

Climate change caused by humans and human activities.

Carbon bubble

Hypothesized overvaluation of fossil fuel companies based on the notion that the current valuation of their assets does not reflect the risk of them becoming stranded.

Carbon Capture and Storage (CCS)

CO2 is captured from emissions at source, liquefied and then stored underground in geological formations, for example in former oil and gas reservoirs.

Carbon Capture, Utilization and Storage (CCUS)

CO2 is captured from emissions at source, utilized in areas including food and drink production, and the production of urea, and/or stored.

Circular economy

Economic approach in which the value of products and materials is maintained for as long as possible, with waste and resource use minimized.

Climate

The average and spread in weather conditions for a particular area over a period of time, defined by the World Meteorological Organization as 30 years.

Climate change

A change in the state of the climate that can be identified by changes in the mean and/or the variability of its properties that persists for an extended period, typically decades or longer (IPCC). This may be caused by natural forcing agents or by humans and human activities.

Climate Change 2021

Refers to the first part of the IPCC’s report from its sixth assessment cycle: Climate Change 2021: The Physical Science Basis. Working Group I Contribution to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, published in August 2021.

Climate Change 2022

Refers to the second part of the IPCC’s report from its sixth assessment cycle: Climate Change 2022: Impacts, Adaptation and Vulnerability. Working Group II Contribution to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, published in February 2022.

De-growth

A planned economic contraction to bring us within our planetary boundaries.

Decoupling

The concept that economic growth can be separated from growth in resource use and the resulting environmental impact. (continued)

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Table 2.5  (Continued) Term

Definition

Externalities

The effects of one party’s activities and operations which are not factored into its assessment of costs, risks and rewards.

Green economy

An economic approach that balances economic progress with environmental and social sustainability.

Greenhouse effect

The process by which greenhouse gases absorb heat and raise the temperature of the atmosphere.

Greenhouse gases

Primarily Carbon Dioxide (CO2), Methane (CH4) and Nitrous Oxide (N2O). Although relatively scarce in our atmosphere (0.1%), they have a potent effect on the climate system.

Planetary boundaries

The environmental limits within which we must remain to ensure the safety of human life.

Representative Concentration Pathways (RCPs)

Developed by the IPCC, RCPs describe future climate scenarios based on different levels of greenhouse gas emissions and concentrations.

Shared Socioeconomic Pathways (SSPs)

A set of scenarios used by the IPCC and others that use socioeconomic factors, including economic growth, population and technological development, to develop different scenarios for emissions based on different speeds and scales of climate policy action.

Steady-state economy

An economy that is not based on increasing levels of production and consumption.

Stranded assets

Assets that have suffered from unanticipated or premature write-downs, devaluations or conversion to liabilities.

Notes 1 Stockholm Resilience Centre (2012) Planetary boundaries, https://www. stockholmresilience.org/research/planetary-boundaries.html (archived at https://perma. cc/9QML-ZPR6) 2 Steffen, W, Richardson, K, Rockström, J et al (2015) Planetary boundaries: Guiding human development on a changing planet, Science, 347 (6223), https://www.science.org/ doi/10.1126/science.1259855 (archived at https://perma.cc/R9ZM-4WHV) 3 IPCC (2021) Climate Change 2021: The Physical Science Basis. Working Group I Contribution to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, https://www.ipcc.ch/report/ar6/wg1/downloads/report/IPCC_AR6_WGI_SPM. pdf (archived at https://perma.cc/AL5A-G83Y)

Climate change and our changing world 4 IPCC (2022) Working Group III contribution to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, https://www.ipcc.ch/report/sixthassessment-report-working-group-3/ (archived at https://perma.cc/8F2J-2ZQ5) 5 World Meteorological Organization (WMO) (2021) The State of the Global Climate 2021, https://public.wmo.int/en/media/press-release/state-of-climate-2021-extreme-eventsand-major-impacts (archived at https://perma.cc/9ER8-92GR) 6 United Nations (2019) UN Report: Nature’s Dangerous Decline ‘Unprecedented’: Species Extinction Rates Accelerating, United States, https://www.un.org/sustainabledevelopment/ blog/2019/05/nature-decline-unprecedented-report/ (archived at https://perma.cc/ TWP6-MXCB) 7 WWF (2020) How many species are we losing? https://wwf.panda.org/discover/our_ focus/biodiversity/biodiversity/ (archived at https://perma.cc/S6DM-8N8G) 8 IPCC (2021) Climate Change 2021: The Physical Science Basis. Working Group I Contribution to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, https://www.ipcc.ch/report/ar6/wg1/downloads/report/IPCC_AR6_WGI_SPM. pdf (archived at https://perma.cc/AL5A-G83Y) 9 Weeman, K (2018) New study finds sea levels rise accelerating, Climate Change: Vital Signs of the Planet, https://climate.nasa.gov/news/2680/new-study-finds-sea-level-riseaccelerating/ (archived at https://perma.cc/33DJ-SAJR) 10 IPCC (2021) Climate Change 2021: The Physical Science Basis. Working Group I Contribution to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, https://www.ipcc.ch/report/ar6/wg1/downloads/report/IPCC_AR6_WGI_SPM. pdf (archived at https://perma.cc/AL5A-G83Y) 11 Ibid 12 Ibid 13 IPCC (2018) Annex I: Glossary. In Global Warming of 1.5°C, https://www.ipcc.ch/sr15/ (archived at https://perma.cc/9R8A-WWMM) 14 Christian Aid (2020) Counting the Cost 2020: A year of climate breakdown, https://www.christianaid.org.uk/sites/default/files/2020-12/Countingpercent20­ thepercent20costpercent202020.pdf (archived at https://perma.cc/BB2Y-UMDU) 15 IPCC (2021) Climate Change 2021: The Physical Science Basis. Working Group I Contribution to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, https://www.ipcc.ch/report/ar6/wg1/downloads/report/IPCC_AR6_WGI_SPM. pdf (archived at https://perma.cc/AL5A-G83Y) 16 IPCC (2022) Working Group III contribution to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, https://www.ipcc.ch/report/sixthassessment-report-working-group-3/ (archived at https://perma.cc/KMT5-5E7Y) 17 IPCC (2021) Climate Change 2021: The Physical Science Basis. Working Group I Contribution to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, https://www.ipcc.ch/report/ar6/wg1/downloads/report/IPCC_AR6_WGI_SPM. pdf (archived at https://perma.cc/AL5A-G83Y)

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Green and Sustainable Finance 18 Carbon Brief (2022) In-depth Q&A: The IPCC’s sixth assessment on how to tackle climate change, https://www.carbonbrief.org/in-depth-qa-the-ipccs-sixth-assessment-onhow-to-tackle-climate-change?utm_content=buffere3b3b&utm_medium=social&utm_ source=twitter.com&utm_campaign=buffer (archived at https://perma.cc/3RS9-8EYG) 19 WMO (2021) Greenhouse Gas Bulletin: Another year another record, https://public.wmo. int/en/media/press-release/greenhouse-gas-bulletin-another-year-another-record (archived at https://perma.cc/L9RX-DZCN) 20 IPCC (2022) Working Group III Contribution to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, https://www.ipcc.ch/report/sixthassessment-report-working-group-3/ (archived at https://perma.cc/TJ9L-KPG8) 21 WMO (2021) Greenhouse Gas Bulletin: Another year another record, https://public.wmo. int/en/media/press-release/greenhouse-gas-bulletin-another-year-another-record (archived at https://perma.cc/L9RX-DZCN) 22 Ibid 23 IPCC (2022) Working Group III Contribution to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, https://www.ipcc.ch/report/sixthassessment-report-working-group-3/ (archived at https://perma.cc/TJ9L-KPG8) 24 Greenhouse Gas Protocol (2021) Portfolio Carbon Initiative, https://ghgprotocol.org/ portfolio-carbon-initiative (archived at https://perma.cc/U3KN-GUQX) 25 Ibid 26 Le Quéré et al (2020) Temporary reduction in daily global CO2 emissions during the COVID-19 forced confinement, Nature Climate Change, 10, pp 647–53, https://doi. org/10.1038/s41558-020-0797-x (archived at https://perma.cc/FLE4-BRYA) 27 Taylor, M and Watts, J (October 2019) Revealed: The 20 firms behind a third of all carbon emissions, Guardian, https://www.theguardian.com/environment/2019/oct/09/ revealed-20-firms-third-carbon-emissions (archived at https://perma.cc/2BFS-LUVU) 28 IPCC (2022) IPCC’s Sixth Assessment Report (AR5) https://www.ipcc.ch/assessmentreport/ar6/ (archived at https://perma.cc/4CZ6-F2D8) 29 IPCC (2018) Special Report: Global Warming of 1.5°C, https://www.ipcc.ch/sr15/ (archived at https://perma.cc/7CT2-XPFD) 30 IPCC (2021) Climate Change 2021: The Physical Science Basis. Contribution of Working Group I to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, https://www.ipcc.ch/report/ar6/wg1/ (archived at https://perma.cc/F7WR-UCDU) 31 IPCC (2022) Climate Change 2022: Impacts, Adaptation and Vulnerability. Contribution of Working Group II to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, https://www.ipcc.ch/report/sixth-assessment-report-working-group-ii/ (archived at https://perma.cc/5GJ3-JEM3) 32 IPCC (2022) Climate Change 2022: Mitigation of Climate Change. Contribution of Working Group III to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, https://www.ipcc.ch/report/sixth-assessment-report-working-group-3/ (archived at https://perma.cc/WHU9-HDFH)

Climate change and our changing world 33 Hausfather, Z (2018) Explainer: How ‘shared Socioeconomic Pathways’ explore future climate change, Carbon Brief, https://www.carbonbrief.org/explainer-how-sharedsocioeconomic-pathways-explore-future-climate-change/ (archived at https://perma.cc/ SX32-ZNZ3) 34 Stockholm Resilience Centre (2018) Planet at risk of heading towards ‘Hothouse Earth’ state, https://www.stockholmresilience.org/research/research-news/2018-08-06planet-at-risk-of-heading-towards-hothouse-earth-state.html (archived at https://perma. cc/8BTL-DCEX) 35 IPCC (2022) Climate Change 2022: Impacts, Adaptation and Vulnerability. Working Group II Contribution to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change, https://report.ipcc.ch/ar6wg2/pdf/IPCC_AR6_WGII_ SummaryForPolicymakers.pdf (archived at https://perma.cc/8U3S-S6NE) 36 IPCC (2018) Special Report: Global Warming of 1.5°C, https://www.ipcc.ch/sr15/ (archived at https://perma.cc/EV58-PY74) 37 Oxfam (2020) Confronting Carbon Inequality, https://www.oxfam.org/en/research/ confronting-carbon-inequality (archived at https://perma.cc/QEK7-H8Z9) 38 Climate Central (nd) Flooded Future: Global vulnerability to sea level rise worse than previously understood, https://sealevel.climatecentral.org/research/reports/flooded-futureglobal-vulnerability-to-sea-level-rise-worse-than-previously/ (archived at https://perma.cc/ TP9U-5ABE) 39 UK Met Office/World Food Programme (2016) Food Security and Climate Change Assessment: Sudan, https://www.metoffice.gov.uk/binaries/content/assets/metofficegovuk/ pdf/business/international/food_security_climate_change_assessment_sudan.pdf (archived at https://perma.cc/PV84-S4QC) 40 IPCC (2014): AR5 Synthesis Report Annex II Glossary. Available at: www.ipcc.ch/site/ assets/uploads/2018/02/WGIIAR5-AnnexII_FINAL.pdf (archived at https://perma.cc/ R43E-MRHQ) 41 IPCC (2022) Working Group III Contribution to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change (p49) https://www.ipcc.ch/report/sixthassessment-report-working-group-3/ (archived at https://perma.cc/H26K-XJ4S) 42 Department for Business, Energy & Industrial Strategy (2018) 2018 UK Greenhouse Gas Emissions, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/ attachment_data/file/863325/2018-final-emissions-statistics-summary.pdf (archived at https://perma.cc/RH38-6KS4) 43 IEA (nd) A New Era for CCUS, https://www.iea.org/reports/ccus-in-clean-energytransitions/a-new-era-for-ccus#growing-ccus-momentum (archived at https://perma.cc/ P7G8-MYXV) 44 Mcsweeny, R and Tandon, A (2020) Global Carbon Project: Coronavirus causes ‘record fall’ in fossil-fuel emissions in 2020, Carbonbrief.org, https://www.carbonbrief.org/globalcarbon-project-coronavirus-causes-record-fall-in-fossil-fuel-emissions-in-2020/ (archived at https://perma.cc/UQ92-NBV9)

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Green and Sustainable Finance 45 Stern, N (2006) The Economics of Climate Change: The Stern Review, https://www.lse. ac.uk/granthaminstitute/publication/the-economics-of-climate-change-the-stern-review/ (archived at https://perma.cc/4Z5P-5SZ6) 46 Economist Intelligence Unit (2015) The Cost of Inaction: Recognizing the value at risk from climate change, https://eiuperspectives.economist.com/sustainability/cost-inaction (archived at https://perma.cc/872U-CQA7) 47 Swiss Re Institute (2021) The Economics of Climate Change: No action not an option, https://www.swissre.com/institute/research/topics-and-risk-dialogues/climate-and-naturalcatastrophe-risk/expertise-publication-economics-of-climate-change.html (archived at https://perma.cc/2P8G-BLB7) 48 Swiss RE Institution (2021) The Economics of Climate Change: Climate change poses the biggest long-term risk to the global economy. No action is not an option, https:// www.swissre.com/institute/research/topics-and-risk-dialogues/ (archived at https://perma. cc/4SDQ-62SM) 49 IEA (2021) Net Zero by 2050 – A Roadmap for the Global Energy Sector, https://www. iea.org/reports/net-zero-by-2050 (archived at https://perma.cc/4VXP-ZKLE) 50 Carbon Tracker (2021) Beyond Petrostates: The burning need to cut oil dependence in the energy transition, https://carbontracker.org/reports/petrostates-energy-transition-report/ (archived at https://perma.cc/6PXY-JQ8B) 51 Fixsen, R (2019) Sweden goes fossil free with €4.3bn of premium pension assets, IPE, https://www.ipe.com/sweden-goes-fossil-free-with-43bn-of-premium-pensionassets/10034919.article (archived at https://perma.cc/RY7X-EKV3) 52 UN Environment Programme (UNEP) (2018) Green Economy, https://www.unep.org/ regions/latin-america-and-caribbean/regional-initiatives/promoting-resource-efficiency/ green (archived at https://perma.cc/26VV-8YY6) 53 Build Back Better, https://www.buildbackbetter.org.uk/ (archived at https://perma. cc/33MU-QQEB); PBC Today (2021) PM launches new Build Back Better Council, https://www.pbctoday.co.uk/news/planning-construction-news/build-back-bettercouncil/87614/ (archived at https://perma.cc/423Q-TS7S) 54 OECD (nd) What is green growth and how it can help deliver sustainable development? https://www.oecd.org/general/whatisgreengrowthandhow­canithelpdeliversustainabledevel opment.htm (archived at https://perma.cc/2R63-PGYP) 55 UN (2012) Green Growth, https://sustainabledevelopment.un.org/index.php?menu=1447 (archived at https://perma.cc/V4AJ-8SRP) 56 Zero Waste Europe (nd) Press Release: The 4 guiding principles for a Circular Economy, https://zerowasteeurope.eu/press-release/press-release-what-is-needed-for-circulareconomy/ (archived at https://perma.cc/Y4QW-M3FY) 57 McKinsey (2017) Mapping the Benefits of a Circular Economy, https://www.mckinsey. com/business-functions/sustainability/our-insights/mapping-the-benefits-of-a-circulareconomy# (archived at https://perma.cc/54RW-EBG7) 58 Rapanui (nd) https://rapanuiclothing.com/the-journey/ (archived at https://perma.cc/ LYJ2-ETS5)

Climate change and our changing world 59 Bani, M et al (2018) Circular Economy Finance Guidelines, https://www.ing.com/ MediaEditPage/Circular-Economy-Finance-guidelines.htm (archived at https://perma. cc/45V7-ZCS7) 60 Ellen MacArthur Foundation (2016) Money Makes the World go Round 61 FinanCE Working Group (2018) ABN AMRO, ING and Rabobank launch finance guidelines for circular economy, https://www.ing.com/Newsroom/News/ABN-AMROING-and-Rabobank-launch-finance-guidelines-for-circular-economy.htm (archived at https://perma.cc/9PCE-K4BP) 62 UN Environment Programme (UNEP) (nd) Guidance on Resource Efficiency and Circular Economy Target Setting, https://www.unepfi.org/publications/guidance-on-resourceefficiency-and-circular-economy-target-setting/ (archived at https://perma.cc/JA3X-LJZ5)

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Building a sustainable financial system International, national, industry and institutional responses Introduction There are many different actors involved in building a sustainable financial system. Individually and collectively, they include: ●●

intergovernmental organizations

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national governments

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central banks and financial regulators

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international financial institutions (IFIs) and multilateral development banks (MDBs)

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scientific and environmental organizations

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non-governmental organizations (NGOs)

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financial services firms

Intergovernmental bodies, national governments and regulatory authorities have a particularly important impact on the speed at which green and sustainable finance develops. They can use legal and regulatory regimes and other policy tools to direct the course of finance, and to influence how green and sustainable finance principles are embedded in organizational strategies. They can also use their convening power to form finance sector coalitions – such as the Principles for Responsible Investment, Principles for Responsible Banking and the Glasgow Financial Alliance for Net Zero.

Building a sustainable finance system

This chapter provides an overview of many of the key institutions and policy, regulatory and market initiatives in green and sustainable finance. Some of these are explored in greater detail in later chapters.

L E A R N I N G OB J ECTI VES On completion of this chapter, you will be able to: ●●

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Identify a range of key actors involved in building a sustainable financial system. Identify the key policy and regulatory frameworks supporting green and sustainable finance. Explain how intergovernmental bodies, governments and other organizations support the development of green and sustainable finance. Describe some key industry initiatives on green and sustainable finance. Explain the ways in which sustainability may be embedded in organizational strategies.

Global policy responses to climate change and sustainability Intergovernmental policy responses The transition to a sustainable, low-carbon economy requires cooperation and interaction between intergovernmental organizations, governments, regulatory authorities, and private sector actors. Climate change is a global problem and – as we explored in the previous chapter – dramatic and sustained action to both mitigate the causes of climate change and adapt to its impacts is necessary to avoid potentially catastrophic and irreversible changes to our planet. In recent years, prompted by the signing of the Paris Agreement in 2015, there has been an acceleration in the number of policy and regulatory measures designed to address climate, environmental and sustainability risks, to promote the growth of green and sustainable finance to address those risks, and to support the transition to a more sustainable, low-carbon world. According to the UNFCCC Standing Committee on Finance (introduced in Chapter 4), by 2020 there were at least 550 recognized policy and regulatory measures, compared with 181 recorded in 2015.1 Most of these are at the national level, along with an increasing number of international policy initiatives. The acceleration of policy and regulatory measures has been

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prompted in large part by the development and publication of ‘net zero’ legislation by countries including France, Norway, New Zealand, Denmark, Sweden and the UK. As more countries create and legislate climate goals, and organizations also commit to reducing or eliminating emissions, some clarity is needed around the terminology used. ‘Net zero’, ‘Net zero carbon emissions’, ‘carbon neutral’, ‘climate neutral’, ‘zero carbon’ and ‘negative emissions’ are sometimes used interchangeably. There are similarities, but also important differences: ●●

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Net zero: balancing carbon dioxide and other greenhouse gas emissions from production and other activities released into the atmosphere with equivalent amounts captured and stored, and/or offset (for example, through buying carbon credits) Net zero carbon emissions: balancing carbon dioxide emissions from production and other activities released into the atmosphere with equivalent amounts captured and stored, and/or offset (carbon dioxide only, not other greenhouse gases). Carbon neutral: a synonym for ‘net zero carbon emissions’ (carbon dioxide only). Climate neutral: a synonym for ‘net zero’ (includes carbon dioxide and other greenhouse gases). Zero carbon: no carbon is emitted through production or other activities; therefore, no carbon needs to be captured or offset. Negative emissions: the activity of removing carbon dioxide from the atmosphere. Technologies used include afforestation and reforestation, soil carbon sequestration, and direct air capture

READING The Race to Zero, and the Race to Resilience2 Race to Zero In advance of COP26 in November 2021, more than 120 countries committed to achieving net zero carbon emissions by 2050, in a movement known as ‘Race to Zero’, led by the UN’s High-Level Champions for Climate Action. According to the UNFCCC, this is the largest ever alliance committed to climate change. The participating countries have been joined by more than 1,000 cities, 60 regions, 5,000 businesses, 400 of the largest investors and 1,000 universities, accounting for some 25 per cent of global CO2 emissions and over 50 per cent of global GDP. A Finance Sector Expert Group has been established to advise the High-Level Champions on criteria relevant to the finance sector.

Building a sustainable finance system

Race to Resilience It’s becoming clear that we will need to live with the effects of climate change, known as ‘climate adaptation’, while reducing emissions. To reflect this, the ‘Race to Zero’ campaign launched a sister campaign, the ‘Race to Resilience’. This seeks to protect the 4 billion people who are most vulnerable to climate risks such as extreme heat, droughts and flooding, by 2030. It’s a clear sign that countries need to both adapt and mitigate the effects of climate change. Mitigation alone will no longer suffice. The Race to Resilience will involve significant infrastructure projects, which should have a positive social impact, too. Examples include transforming urban slums into safe and clean cities, equipping smallholder farmers with equipment to overcome the challenges they will face, and reinforcing coastal homes with flood defences.

To date, the great majority of climate change mitigation plans developed and adopted by countries and organizations have tended to set targets for achieving net zero greenhouse gas emissions, or the more limited aim of carbon neutrality by 2050. China, as we will see in the case study below, has set a target of carbon neutrality by 2060; India has pledged to achieve net zero by 2070. Many countries and organizations have also set shorter-term (interim) goals, often referencing 2030, since in order to achieve net zero or carbon neutrality by mid-century substantial progress must be made before then. Countries’ plans to achieve their climate goals, aligned with the objectives of the Paris Agreement, are set out in Nationally Determined Contributions (NDCs), which are monitored by the UNFCCC. At the time of writing the UNFCCC reports that 194 Parties (i.e. signatories to the Paris Agreement) have submitted their first NDCs, and 13 have submitted their second.3 For example: ●●

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The European Commission plans to cut greenhouse gas emissions by at least 55 per cent compared to pre-1990 levels by 2030. This is part of its 2030 Climate Target Plan, a key milestone to achieve towards the EU’s objective of becoming climate neutral (i.e. net zero greenhouse gas emissions) by 2050. In the UK, the government plans to cut emissions by 68 per cent by 2030, an interim target towards the goal of net zero by 2050. Switzerland aims to reduce greenhouse gas emissions by at least 50 per cent by 2030 compared with 1990 levels, which will require emissions reductions of at least 35 per cent in the period 2021–30. The United States has set a target of reducing net greenhouse gas emissions by 50–52 per cent below 2005 levels by 2030.

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Costa Rica has adopted a different approach, committing to emit no more than 106.53 million tonnes of carbon emissions between 2021 and 2030.

Countries’ NDCs and climate action plans should, in theory, be aligned with the objective of the Paris Agreement to limit global warming to below 2°C, and as close as possible to 1.5°C, above pre-industrial levels. The extent to which this is the case is monitored by the UNFCCC and by independent bodies such as The Climate Action Tracker, which evaluates countries’ climate action plans, targets and the measures taken to achieve these; it covers 39 countries plus the EU that are responsible for approximately 80 per cent of global emissions.4 Many NDCs and climate action plans assume that new technologies, including carbon capture and storage, and yet-to-be-developed techniques to remove large quantities of carbon from the atmosphere, will play important roles in helping countries achieve net zero. As we saw in Chapter 2, carbon capture and storage technology is in its infancy, and there are significant challenges to developing and deploying it at the scale needed to play a significant role in countries’ net zero transitions, and the global transition overall.

CASE STUDY China’s journey to net zero5 At the time of writing, in 2021, China is responsible for approximately 28 per cent of the world’s greenhouse gases. Spurred on by economic growth in recent decades, China accounts for around half of all global consumption of steel, copper, aluminium and cement. Studies show that, over the past 20 years, carbon dioxide emissions grew six times faster in China than in the rest of the world. China seems an unlikely front runner, therefore, in the Race to Zero. China intends to show global leadership, however. A key part of the nation’s 14th Five-Year Plan prioritizes reducing emissions and improving low-carbon technologies. President Xi Jinping has set the goal of China becoming carbonneutral by 2060. In doing so, the country will join the ranks of other nations that have set mid-century emissions targets. This is a tall order for China, which will need to reduce carbon emissions by as much as 90 per cent. The rewards will be worthwhile, however. If China can reach its goal, which would represent the largest national climate commitment to date, this will reduce global warming by around 0.25°C. As one of the countries most at risk from flooding and drought, China will mitigate damage to its own cities, economy and society. Furthermore, the commitment offers a significant opportunity to generate economic growth and employment, building on China’s substantial financial, technological and human resources and capabilities. The eyes of the world will be on China.

Building a sustainable finance system

QUICK QUESTION What net zero target(s), and plans to achieve them, have been developed in the country where you live and work?

Three major international agreements have focused on limiting average global temperature increases and combating climate change, which we briefly introduced in the previous chapter.

United Nations Climate Convention Agreed in 1992, and ratified by 197 parties to the Convention, the United Nations Framework Convention on Climate Change (UNFCCC) is the main international treaty for tackling climate change. It seeks to prevent dangerous human-made interference with the global climate system. The ‘Conference of the Parties’, generally known as the ‘COP’, is the governing body of the UNFCCC. The COP meets annually to review the implementation of the Convention and agreed climate change instruments, and to provide a forum for the negotiation of new climate change agreements and policies. At COP21, held in Paris in 2015, the Paris Agreement (see below) was finalized and announced.

Kyoto Protocol Before the Paris Agreement came into effect, the world’s only binding instrument for cutting greenhouse gas emissions was the 1997 Kyoto Protocol. The Protocol has been ratified by 192 of the UNFCCC Parties, but some major emitters of greenhouse gases either failed to ratify (the United States) or were considered developing countries that had no legal obligations to reduce emissions (such as China and India, although India subsequently joined in 2017). This meant that the Kyoto Protocol covered, in its first period, only about 12 per cent of global emissions. Two commitment periods were agreed: ●●

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1st period (2008–12) – industrialized countries committed to reducing emissions by an average of 5 per cent below 1990 levels. 2nd period (2013–20) – parties who joined in this period (including India) committed to reducing emissions by at least 18 per cent below 1990 levels.

One of the most important achievements of the Kyoto Protocol was the establishment of flexible market mechanisms, based on emission permits, to begin to reduce greenhouse gas emissions.

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Paris Agreement The Paris Agreement of December 2015 is the first universal, legally binding global climate agreement, which entered into force in 2020. By March 2022, 192 of the 197 UNFCCC countries plus the EU had ratified the Agreement, including the United States, which re-joined after pulling out during the Trump administration. Article 9 states that developed countries ‘should continue to take the lead in mobilizing climate finance from a wide variety of sources’. The Paris Agreement provides a pathway to limit global temperature rises to below 2°C and seeks to limit such increases to 1.5°C above pre-industrial levels. It is for each country, however, to determine the action they will take on climate change mitigation and adaptation. As a result, some national governments have transcribed their own targets into law through national legislation. Whilst this is encouraged by the Paris Agreement, it is not a requirement. The Agreement explicitly recognizes countries’ ‘differing situations and circumstances’; this has resulted in criticism from some ­environmental activists. The three key objectives set out in Article 2 of the Paris Agreement are: ●●

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2.1 (a) Holding the increase in the global average temperature to well below 2°C above pre-industrial levels and pursuing efforts to limit the temperature increase to 1.5°C above pre-industrial levels, recognizing that this would significantly reduce the risks and impacts of climate change. 2.1 (b) Increasing the ability to adapt to the adverse impacts of climate change and foster climate resilience and low greenhouse gas emissions development, in a manner that does not threaten food production. 2.1 (c) Making finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development.6

Recognition of the key role of finance in tackling climate change, as set out in Article 2.1 (c), is a major influence on the growth of green and sustainable finance. Parties to the Agreement are required to submit climate action plans (NDCs), and there is a binding requirement for countries to assess and review progress against these plans – this is the ‘legally binding’ part of the Agreement. The intention is that this will encourage governments to continue to raise their targets for mitigation and adaptation measures, collectively limiting global temperature rises. It was originally agreed that countries should submit their first NDCs by 2020, but this was delayed until COP26 in 2021 because of the Covid-19 pandemic. Every five years, a global stocktake of NDCs submitted will be made to assess the world’s collective progress towards the Paris Agreement’s objectives; the first stocktake is taking place between 2021 and 2023, overseen by the UNFCCC.7

Building a sustainable finance system

To support the UNFCCC and other international and national bodies concerned with climate change, in 1988 the Intergovernmental Panel on Climate Change (IPCC) was established by the World Meteorological Organization (WMO) and the United Nations Environment Programme, with a remit to assess and report on the science related to climate change. The IPCC, which we described in Chapter 2, analyses a wide range of scientific papers published each year to provide a comprehensive, annual summary of climate change science, future impacts and risks, and how adaptation and mitigation can reduce those risks. The IPCC plays a key role in ensuring that international agreements on climate change, and national policies and legislation aligned to these, are based on strong scientific foundations. As we examined in the previous chapter, the IPCC’s 2018 Special Report recommended urgent action to limit global temperature rises to below 1.5°C rather than the previous consensus of below 2°C.8 The IPCC’s Working Groups’ reports from its current (sixth) assessment cycle, AR6, Climate Change 20219 and Climate Change 2022,10 set out a strong scientific case for urgent and ambitious action to achieve this. International agreements such as those just outlined are often not themselves legally binding at the national level. Many national governments, therefore, have aligned their plans and measures on climate change mitigation and adaptation with national legislation, as set out in the case study below.

CASE STUDY Climate change legislation and policy in the UK11 The Climate Change Act 2008 is the basis for the UK’s approach to tackling and responding to climate change. It stipulates that emissions of carbon dioxide and other greenhouse gases must be reduced, and climate change risks prepared for. The Act also established the framework for delivering these requirements. The Act came into law on 26 November 2008, which meant that the UK became the first country in the world to have a long-term, legally binding target for reducing greenhouse gas emissions. The Act incorporates: ●●

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a target to reduce emissions by 80 per cent by 2050 (compared to 1990 levels) and a requirement to set legally binding, five-year ‘carbon budgets’ (the first five have been enacted in legislation and run to 2032); the establishment of a Committee on Climate Change to advise the government on emissions targets and report to Parliament on progress; and a government commitment to carry out national climate change risk assessments and develop a National Adaptation Plan, both to be reviewed every five years.

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In June 2019, via an amendment to the 2008 Climate Change Act, the UK became the first major economy to agree legislation to enshrine a net zero target for greenhouse emissions by 2050. In December 2020, the UK submitted its updated NDC to the UNFCCC. The UK Government committed to reducing the UK’s NDCs by 68 per cent (from pre-1990 levels) by 2030. At the same time, the Committee on Climate Change published its sixth Carbon Budget Report. The report found there needed to be a 78 per cent reduction in emissions by 2035 if the UK were to achieve its net zero target by 2050. This highlighted four priority areas: ●● ●●

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investing in low-carbon solutions, including fuel-efficient and electric cars; expanding the low-carbon energy supply, and in particular making offshore wind the backbone of the UK’s power generation; reducing demand for carbon-intensive activities by, for example, changing diets, improving insulation and travelling less by car; changing land use to promote carbon capture and storage, and in particular increasing woodland coverage in the UK by 5 per cent to 18 per cent.

As well as being covered by the Climate Change Act, Scotland, Wales and Northern Ireland have separate climate change policies that include: ●●

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The Climate Change (Scotland) Act 2009 committed Scotland to a 42 per cent reduction in emissions by 2020 and annual reductions between 2010 and 2050. In September 2019, the Scottish Government published more ambitious legislation, setting targets to reduce emissions by 75 per cent by 2030, and to becoming net zero by 2045. A Citizens’ Assembly on Climate Change has been established. This group has around 100 members of society drawn from across Scotland, and will make recommendations to ministers on how to achieve the transition to net zero. The Environment (Wales) Act 2016 provides for the setting of emissions reduction targets to 2050, including at least an 80 per cent reduction (compared with 1990 levels) by 2050, and five-year carbon budgets. The first two carbon budgets (2016–2020 and 2021–2025) were set in 2018. The Northern Ireland Executive, in its Programme for Government (2011–2015), has set a target of continuing to work towards reducing greenhouse gas emissions by at least 35 per cent (compared with 1990 levels) by 2025. In December 2020, the Climate Change Committee advised Northern Ireland to cut their emissions by at least 82 per cent by 2050. This would involve either implementing climate laws in Northern Ireland, or the country becoming part of the UK’s overarching climate laws and strategy.

Building a sustainable finance system

Global financial sector responses: the United Nations and the Glasgow Financial Alliance for Net Zero The UN is an intergovernmental organization established in 1945 to promote international cooperation and to create and maintain international order. As of 2022, 193 independent sovereign states are members of the UN. As outlined above, the UN plays the leading global role in tackling climate change, acting through the UNFCCC and other agencies. The UN has also established a wide range of initiatives to mobilize the business, finance and regulatory communities to address climate-related financial risks (and broader environmental and other sustainability risks), and to align finance and sustainability more generally. In this section, we briefly introduce the key UN agencies and initiatives that finance professionals should be aware of, many of which we will return to and explore in more detail in later chapters.

United Nations Environment Programme Finance Initiative (UNEP FI) UNEP FI is a partnership between the United Nations Environment Programme and the global financial services sector, created at the 1992 Earth Summit with a mission to promote sustainable finance. Over 450 financial institutions, including banks, insurers and investors, are members and work with UNEP FI to understand environmental and societal challenges, why they matter to finance, and how to actively participate in addressing them. The foundation of UNEP FI is the Statement of Commitment by Financial Institutions on Sustainable Development.12 By signing up to the Statement, financial institutions recognize the role of finance in promoting sustainable development, and commit to the integration of environmental and social considerations into all aspects of their operations. UNEP FI has convened, founded and supported many leading finance sector initiatives to align finance and sustainability, including the Principles for Responsible Investment (PRI), Responsible Banking (PRB) and Sustainable Insurance (PSI), all introduced below. More recently, it has convened the Net Zero Banking Alliance, Net Zero Asset Owner Alliance, Net Zero Asset Manager Initiative and Net Zero Financial Service Providers Alliance, all of which seek to align finance with net zero by 2050. These, and the Glasgow Financial Alliance for Net Zero (GFANZ), which brings these alliances together in a single coalition, are also described below. UNEP FI also supports the Sustainable Stock Exchanges Initiative (SSEI), launched in 2012 with UNCTAD, UN Global Compact and the PRI, whose members include exchanges accounting for almost all publicly listed capital markets. For more information, see https://www.unepfi.org/

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Principles for Responsible Investment (PRI) In early 2005, the United Nations Secretary-General invited a group of the world’s largest institutional investors to join a process to develop the Principles for Responsible Investment (PRI). Launched in 2006, these are a voluntary and aspirational set of six investment principles that offer a menu of possible actions for incorporating environmental, social and governance issues into investment practice. Originally convened by UNEP FI, the PRI is now an independent, UN-supported global network of investors (signatories) working together to implement the principles and, more generally, to align investment strategies and decision making with the objectives of the Paris Agreement and other sustainability goals. As of 2022, the Principles have some 4,600 signatories, representing more than $100 trillion in assets under management (AUM). The PRI are explored in more detail in Chapter 9. For more information, see https://www.unpri.org/

Principles for Sustainable Insurance (PSI) Launched at the 2012 UN Conference on Sustainable Development, the Principles for Sustainable Insurance (PSI) serve as a global framework for the insurance industry to address environmental, social and governance risks and opportunities. Endorsed by the UN Secretary-General, the Principles have led to the largest collaborative initiative between the UN and the insurance industry. As of 2022, 140 organizations had adopted the Principles, including insurers representing over 25 per cent of world premium volume and $14 trillion in assets under management. The PSI are explored in more detail in Chapter 10. For more information, see https://www.unepfi.org/psi/

UN Principles for Responsible Banking (PRB) The Principles for Responsible Banking (PRB) provide a framework for banks to incorporate green and sustainable finance principles and practice in their business models, aligning their strategies and operations with the UN Sustainable Development Goals and the objectives of the Paris Agreement. Launched in September 2019 at the UN General Assembly, by 2022 the number of signatories had grown to more than 300 banks representing around 45 per cent of global banking assets and serving more than 2 billion customers. The PRB are explored in more detail in Chapter 6. For more information, see https://www.unepfi.org/banking/bankingprinciples/

The UN-Convened Net Zero Alliances Beginning in 2019, UNEP FI and a range of partners established three alliances, introduced below, which bring together groups of banks, investors and insurers making a common commitment to achieve net zero by 2050. Whilst there is considerable

Building a sustainable finance system

overlap with the membership and aims and objectives of the PRB, PRI and PSI described above, the Net Zero Alliances focus on and require a commitment to a transition to net zero consistent with a maximum temperature rise of 1.5°C above pre-industrial levels rather than a broader sustainability/sustainable finance remit.

UN-Convened Net Zero Banking Alliance Founded in 2021, the NZBA comprises more than 100 banks from 40 countries representing nearly 40 per cent of total global banking assets. NZBA members commit to: ●●

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transitioning operational and attributable GHG emissions from their lending and investment portfolios to align with pathways to net zero by 2050 or sooner; setting an interim 2030 and a 2050 target, with intermediary targets to be set every five years from 2030 onwards; focusing the interim targets on priority sectors where they can have the most significant impact; annually publishing absolute emissions and emissions intensity in line with best practice and disclosing progress against a board-level reviewed transition strategy setting out proposed actions and climate-related sectoral policies; and taking a robust approach to the role of offsets in transition plans.

For more information, see https://www.unepfi.org/net-zero-banking/

UN-Convened Net Zero Asset Owner Alliance Founded in 2019, the NZAOA is a group of some 70 institutional investors with $10 trillion assets under management. Recognizing that there are many existing investor initiatives seeking to address climate change and align finance with the goals of the Paris Agreement (many of which are introduced later in this chapter), the Alliance aims to work with these to ensure greater alignment, coordination and consistency in investor action and messaging. In 2022, the NZAOA published a new, more ambitious target-setting protocol13 that raises members’ ambitions in terms of setting interim portfolio decarbonization targets. It is recommended that absolute emissions reductions for the period 2020 to 2025 should range between 22 per cent and 32 per cent, with reductions for the period 2020 to 2030 ranging between 49 per cent and 65 per cent or beyond. In addition, members are encouraged to press asset managers to publicly commit to supporting a transition to net zero aligned with a maximum 1.5°C increase in global warming above pre-industrial levels. For more information, see https://www.unepfi.org/net-zero-alliance/

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UN-Convened Net Zero Insurance Alliance Established in 2021, the NZIA is a group of over 20 leading insurers, all signatories to the Principles for Sustainable Insurance, representing more than 11 per cent of world premium volume. Members of the Alliance commit to transition their insurance and reinsurance underwriting portfolios to net zero greenhouse gas emissions by 2050. As a recent initiative, the Alliance intends to expand to include market participants such as brokers, and market bodies such as insurance associations. For more information, see https://www.unepfi.org/net-zero-insurance/ In addition to the three Net Zero Alliances listed, the Net Zero Asset Managers Initiative and Net Zero Financial Services Providers Alliance share similar aims and objectives, but are not finance sector groupings convened by the UN. They are, however, accredited by the UNFCCC’s Race to Zero campaign and are also encompassed by the Glasgow Financial Alliance for Net Zero (GFANZ). Both are introduced in more detail below.

Co-ordinating Climate Action: The Glasgow Financial Alliance for Net Zero (GFANZ) As can be seen above, there are a wide range of finance sector alliances and initiatives that aim to support collective action to tackle climate change and wider environmental and social sustainability issues. Whilst each coalition helps align finance with the objectives of the Paris Agreement (and, in some cases, the UN SDGs and broader sustainability goals), the landscape can be confusing to navigate for policymakers and others – including financial institutions themselves. The UN-Convened Net Zero Alliances seek to coordinate and harmonize approaches to a certain extent within each sub-sector, but aligning finance overall with a pathway to net zero by midcentury requires further coordination. For this reason, in April 2021 the Glasgow Financial Alliance for Net Zero14 (GFANZ) was launched. GFANZ coordinates the work of the existing UN Net Zero Alliances and other groups based on a common commitment from members to (a) align lending and investment portfolios with net zero emissions by 2050, (b) set 2030 interim targets and (c) use science-based guidelines to do so. GFANZ aims to promote integration, not proliferation, of existing initiatives and groups.

READING The Glasgow Financial Alliance for Net Zero15 The Glasgow Financial Alliance for Net Zero (GFANZ), chaired by Mark Carney, UN Special Envoy on Climate Action and Finance, brings together over 450 financial firms from 45 countries (responsible for assets in excess of $130 trillion) from the leading net zero initiatives across the financial system in one sector-wide coalition.

Building a sustainable finance system

GFANZ members must use science-based guidelines to reach net zero emissions by 2050, cover all emissions scopes, include 2030 interim target settings, and commit to transparent reporting and accounting in line with the UNFCCC Race to Zero criteria. Enhanced in 2022, the Race to Zero criteria require organizations (including GFANZ members) to phase out the use and financing of fossil fuels. GFANZ is working to mobilize the trillions of dollars necessary to build a global zero emissions economy and deliver the goals of the Paris Agreement, limiting global temperature rises to 1.5°C above pre-industrial levels. It provides a forum for strategic coordination among the leadership of finance institutions from across the finance sector to accelerate the transition to a net zero global economy. GFANZ’s activities are focused on seven key areas:16 ●●

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Sectoral pathways: catalysing alignment between financial institutions and major global industries on sector-specific pathways to reach net zero emissions. Real economy transition plans: accelerating decarbonization in the real economy by describing financial sector expectations of transition plans from the companies the sector engages with and finances. Financial institution transition plans: driving convergence around sector-wide best practices for financial institutions in designing and implementing credible net zero transition plans. Portfolio alignment measurement: supporting the development and effective implementation of portfolio alignment metrics for financial institutions, and driving convergence in the way portfolio alignment is measured and disclosed. Mobilizing private capital: supporting the mobilization of private capital to emerging markets and developing economies through private sector investments and public-private collaboration. Policy: advocating for the public policy needed to accelerate investment in net zero-aligned activities and organizations. Building commitment: broadening the nature and number of financial firms that are credibly working towards net zero.

GFANZ includes the UN-convened Net Zero Banking, Asset Owners and Insurance Alliances, plus the Net Zero Asset Managers Initiative, Net Zero Financial Services Providers Alliance, Net Zero Investment Consultants Initiative and Paris-Aligned Investment Initiative. Banks, insurers, investors and others participate in GFANZ through one of these groups. By bringing together leading existing and new net zero finance initiatives together in one sector-wide strategic forum, GFANZ will catalyse strategic and technical coordination on the steps firms need to take to align with a net zero future.

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In 2022, GFANZ published guidance for members to support transition planning, recommending four key approaches to be included in their net zero transition plans: 1 Financing the development and scaling of climate solutions. 2 Financing companies that are already aligned to a 1.5°C pathway. 3 Financing the transition of companies according to transparent and robust net zero transition plans in line with 1.5°C-aligned sectoral pathways. 4 Financing the accelerated, managed phase-out of high-emitting physical assets.17 By adopting a common (albeit voluntary) approach to transition planning, GFANZ aims to bring consistency and comparability – and hence credibility – to financial institutions’ commitments and decarbonization strategies and plans.

QUICK QUESTION Which of the above alliances and groups is your organization, or an organization you are familiar with, a member of? What does this mean in terms of any commitments made?

United Nations Development Programme (UNDP) The UNDP is the UN’s development agency, working to eradicate poverty, reduce inequalities and exclusion, and build resilience. It plays a critical role in helping countries achieve the UN Sustainable Development Goals (SDGs) introduced in Chapter 1. In this context, the UNDP works with other intergovernmental organizations, national governments, the finance sector and NGOs, launching the Sustainable Finance Hub to help align economic policies, financial systems, lending, investment and financial innovation with the SDGs.18 Two key UNDP-led initiatives are the Framework for SDG Aligned Finance,19 which seeks to identify objectives, actions, barriers and indicators for SDG alignment, and the UNDP Task Force on Digital Financing of the Sustainable Development Goals20 (which we examine in more detail in Chapter 11). The UNDP has also taken the lead in developing nature-based solutions to development and economic challenges, including nature-based finance. For more information, see https://sdgfinance.undp.org

Building a sustainable finance system

Green Climate Fund Established in 2010 by the UNFCCC, the Green Climate Fund aims to support the efforts of developing countries to respond to the challenges of climate change. Following the 2015 Paris Agreement, the Fund was given an important role in leading climate change mitigation and adaptation efforts, using public finance to stimulate private investment, and aiming to: ●●

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catalyse the flow of climate finance into low-emission and climate-resilient development, driving a paradigm shift in the global response to climate change; and support climate adaptation and resilience in areas that are highly vulnerable to the effects of climate change, in particular least developed countries (LDCs), small island developing states (SIDS) and African states.

As of March 2022, approximately $10 billion had been pledged to the Green Climate Fund, supporting (to date) 190 projects, reducing greenhouse gas emissions by 2 billion tonnes CO2e and helping more than 600 million individuals improve their climate resilience. The Fund works in a manner similar to but more focused than Multilateral Development Banks (MDBs), explored in Chapter 8. Investments can be in the form of grants, loans, equity or guarantees, with approximately 40 per cent focused on mitigation, 25 per cent on adaptation and the remainder on a combination of these. For more information, see https://www.greenclimate.fund

Global financial sector responses: central banks and financial regulators There is a great deal of work being undertaken by international bodies and national central banks and financial regulators to address climate-related financial risks (and broader environmental and other sustainability risks) and to align finance and sustainability more generally. In this section, we briefly introduce the key global bodies that finance professionals should be aware of, some of which we will return to and explore in more detail in later chapters.

G20 The G20 (Group of Twenty) is an international forum for finance ministers and central bank governors from 20 major economies. Currently, these are Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, the United Kingdom, the United States and the European Union. Founded in 1999, the G20 aims to discuss and coordinate policy relating to strengthening the global economy, including improving international financial stability.

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In December 2015, a G20 Sustainable Finance Study Group (SFSG) was established (originally as the Green Finance Study Group), co-chaired by the central banks of China and the United Kingdom. Recognizing the need to scale up green finance over the coming decade, the Study Group’s mandate was to ‘identify institutional and market barriers to green finance and, based on country experiences, develop options on how to enhance the ability of the financial system to mobilize private capital for green investment’; this was subsequently expanded to include wider aspects of sustainable development. The SFSG’s 2018 report21 identified three priorities for developing sustainable finance through the private sector: ●●

creating a wider range of, and encouraging investment in, sustainable assets;

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developing and scaling up sustainable private equity and venture capital;

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utilizing digital technologies to advance the practice and uptake of sustainable finance.

In 2021, finance ministers and central bank governors endorsed the reestablishment of the SFSG to become the ‘G20 Sustainable Finance Working Group’ (G20 SFWG). The new group will focus on developing an evidence-based and climate-focused G20 sustainable finance roadmap, improving sustainability reporting, identifying sustainable investments and aligning International Financial Institutions’ activities with the aims and objectives of the Paris Agreement. These are examined in more detail in the G20 SFWG’s 2021 Synthesis Report, available online.22

Financial Stability Board Established by the G20, the Financial Stability Board (FSB) brings together central banks and financial regulators to promote international financial stability. In 2015, the G20 asked the FSB to consider the risks of a rapid transition to a low-carbon world, which it viewed as having the potential to be a serious systemic threat to the stability of the financial sector, as discussed in earlier units.

Task Force on Climate-related Financial Disclosures In response to the G20’s request, the FSB launched the Task Force on Climate-related Financial Disclosures (TCFD) to develop recommendations in this area. The Task Force published its Final Recommendations in June 2017, and these have been strongly supported and endorsed by a wide range of national and international regulators and policymakers, as we will explore further in Chapter 5 and throughout this book. The TCFD issues a wide range of guidance to help organizations implement its recommendations.

Building a sustainable finance system

As of 2022, more than 3,000 organizations had expressed their support for the TCFD’s recommendations, including more than 60 of the world’s 100 largest public companies. Some jurisdictions, led by the UK, are now also introducing mandatory TCFD disclosures for large companies, including financial institutions. For more information, see https://www.fsb-tcfd.org

The Network for Greening the Financial System Recognizing the need for a wider global regulatory response to the risks of climate change and the need for greater global cooperation and harmonization of approaches to support the development of green and sustainable finance, eight central banks launched the Network for Greening the Financial System (NGFS) at the Paris ‘One Planet Summit’ in December 2017. By 2022, the NGFS had grown to more than 100 members (central banks and financial regulators overseeing economies accounting for the majority of global carbon emissions) and 17 observers, and had become the preeminent body in this area, emphasizing the importance of climate risk to the global financial system and its regulators. The NGFS aims to (a) accelerate and coordinate the work of central banks and financial regulators on climate risk (and wider environmental risks), and (b) support the mainstreaming of green and sustainable finance. In doing so, the NGFS works with a wide range of existing international and national regulatory bodies to feed into and build on their work, rather than duplicating activities already underway elsewhere. This includes working with bodies such as the Sustainable Banking Network (SBN), the Sustainable Insurance Forum (SIF), the recently created Sustainable Finance Network (SFN), initiated by the International Organization of Securities Commissions (IOSCO), and the UNEP Finance Initiative, amongst others. We explore the work of the NGFS, and that of central banks and financial regulators, in more detail in Chapters 5 and 8. For more information, see https://www.ngfs.net/en

Bank for International Settlements The Bank for International Settlements (BIS) is often described as ‘the central bank for the world’s central banks’ and hosts the Basel Committee on Banking Supervision – the main global standard-setter for the prudential regulation of banks worldwide (the Basel Committee). The BIS and Basel Committee have: ●●

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established a Task Force on Climate-related Financial Risks (TFCR) to help coordinate approaches to financial regulation and supervisory approaches related to climate-related risks; begun work to develop and publish principles for the effective management and supervision of climate-related financial risks, encouraging a principles-based

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approach to improving climate risk management and supervisory practices related to climate-related financial risks, building on existing initiatives undertaken by international bodies such as those mentioned above, and national regulators; ●●

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launched the BIS Innovation Hub on Green Finance to explore projects combining technology, finance and sustainability, such as the development of digital platforms to promote transparency and investor engagement with green bonds; and established the Asian Green Bond Fund to channel global central bank reserves to environmentally sustainable projects in the Asia Pacific region via investment in green bonds issued by sovereigns, international financial institutions and corporations.

For more information, see https://www.bis.org/topic/green_finance/cooperation.htm The Basel Committee sets the global framework for calculating the minimum level of capital that banks must hold as a proportion of their assets; this includes setting ‘risk-weights’ for each asset class, which are applied to determine a bank’s exposure to potential losses. The Committee also sets rules and standards for banking supervision and risk management. The current ‘Basel III’ framework is an internationally agreed set of measures, adopted by most developed countries, to strengthen banks’ capital adequacy, liquidity, supervision and risk management, developed in response to the Global Financial Crisis. It is based on three ‘pillars’: ●●

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Pillar 1: defines eligible capital and methods for calculating capital adequacy requirements for credit, market and operational risks. Pillar 2: covers the supervisory review process which ensures that banks have sufficient capital to back all risks and also requires appropriate management of these risks. Pillar 3: defines transparency and minimum disclosure requirements for banks.

The Basel III framework has been criticized for not explicitly addressing the financial stability risks associated with climate and other environmental risks. According to the University of Cambridge Institute for Sustainability Leadership (CISL) and UNEP FI, whilst Basel III does require banks to assess the impact of specific climate and environmental risks on their credit and operational risk exposures, these are mainly transaction-specific risks that affect a borrower’s ability to repay a loan. There is currently no requirement under Basel III for banks to identify and disclose the risks of climate change overall or consider portfolio-wide risks, or for supervisory regimes to monitor potential macroprudential risks to financial stability.23 As noted above, however, the Basel Committee is now developing principles for the management and supervision of climate-related financial risks, which should address this. In addition, some central banks have gone further and have already introduced

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requirements for the disclosure of climate risks and, as we will see below in the case of the European Central Bank (ECB), are moving towards capital requirements and risk weightings related to these.

Coalition of Finance Ministers for Climate Action In 2019, governments from 26 countries joined together to form the Coalition of Finance Ministers for Climate Action. This group aims to use global finance to transition to a low-carbon environment. Since its launch, the group has expanded to include finance ministers from nearly 70 countries representing nearly two-thirds of global GDP and 40 per cent of global CO2 emissions. Countries sign a set of six nonbinding principles, known as the ‘Helsinki Principles’: 1 Align policies and practices with the Paris Agreement commitments. 2 Share experience and expertise with each other in order to provide mutual encouragement and promote collective understanding of policies and practices for climate action. 3 Work towards measures that result in effective carbon pricing. 4 Take climate change into account in macroeconomic policy, fiscal planning, budgeting, public investment management and procurement practice. 5 Mobilize private sources of climate finance by facilitating investments and the development of a financial sector which supports climate mitigation and adaptation. 6 Engage actively in the domestic preparation and implementation of Nationally Determined Contributions (NDCs) submitted under the Paris Agreement. For more information, see www.financeministersforclimate.org

QUICK QUESTION How have financial regulators in your country, or a country you are familiar with, responded to climate change? What are their current priorities?

European and national policy responses Given the diversity of countries in terms of climate, geography, level of economic development, legal and regulatory systems, and the capacity and capability of their finance sectors, measures to address environmental and other sustainability risks and to promote green and sustainable finance need to be tailored to the specific circumstances and requirements of each. International agreements and initiatives (including

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the Paris Agreement) often call for signatories to develop and report on national policies and plans, therefore, rather than seek to implement a single, global approach or model. Many countries have already taken steps to address risks related to climate change and broader environmental and social factors, and to encourage the alignment of their financial systems with sustainability more generally. These include: ●●

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developing and implementing national sustainable finance roadmaps (e.g. the UK’s ‘Greening Finance’ Roadmap24); adopting or adapting international standards, frameworks and guidance and, where relevant (e.g. TCFD), incorporating these into national legislation and regulation (see Chapter 5 for examples of countries that have adopted mandatory TCFD reporting); promoting the harmonization and convergence of green and sustainable finance practices; clarifying the mandates and responsibilities of central banks, regulators and financial institutions relating to climate change and other sustainability factors (see Chapter 8 for examples); enhancing the transparency of information by promoting disclosure standards for climate and environmental risks; supporting market development for green lending, investment and other financial products and services; and building the capacity and capability of the finance sector to support the continued growth of green and sustainable finance (e.g. the UK’s Green Finance Education Charter initiative, introduced later in this chapter).

For reasons of space as well as the pace of policy, regulatory and market developments, it would be impossible here to fully describe national policy responses to promote green and sustainable finance. Instead, we provide an overview of the European Union’s Sustainable Finance Action Plan, which encompasses a range of activities similar to those adopted by many countries with well-developed capital markets and financial sectors. We also briefly introduce and provide links to sustainable finance action plans and similar plans developed by selected G20 countries. As this is a rapidly developing area, it is recommended that green and sustainable finance professionals take active steps to remain up to date with policy, regulatory and market developments in the countries and regions where they work, and/or have professional interests.

Building a sustainable finance system

European Union Sustainable Finance Action Plan and European Green Deal In March 2018, the EU published its Action Plan: Financing Sustainable Growth,25 based on the recommendations of a High-Level Expert Group on Sustainable Finance, established the previous year. The EU Action Plan forms part of wider EU policies and activities, including the European Capital Markets Union, the EU’s Agenda for Sustainable Development, and the implementation of the Paris Agreement. The Action Plan has a number of key elements: ●●

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Developing an EU Taxonomy for sustainable finance, which aims to help define which economic activities are/are not ‘green’ and ‘sustainable’ (published in 2020, the Taxonomy is covered in more detail below). Publishing an EU Green Bond Standard26 to provide clarity as to what can, and cannot, be defined as a ‘green bond’, in order to scale the green bond market, and to protect market integrity by preventing greenwashing. The forthcoming Standard will build on the existing Green Bond Principles and other market standards and guidance. These, and the developing market for green and other forms of sustainable bonds, are explored in more detail in Chapter 7. Creating EU Ecolabels for ‘green’ retail financial products to help investors easily identify investments that comply with agreed criteria, based on the EU Taxonomy.27 By improving information for retail investors, this should encourage flows of investment into sustainable products and funds, and help prevent greenwashing. Labelling is discussed in more detail in Chapter 9. Introducing new transparency and disclosure requirements for financial institutions providing or advising on investment and mutual funds, and pensions – the Sustainable Finance Disclosures Regulation (SFDR), which comes into effect in 2023.28 The SFDR is examined in Chapter 9. Requiring insurance firms, investment firms and other financial advisers to provide advice on the environmental and social aspects of financial products and services, and to take account of their clients’ sustainability preferences and objectives.29 Incorporating sustainability in prudential requirements for banks and insurers, including considering a ‘green supporting factor’ that might reduce capital requirements for green and/or sustainable investments. Enhancing transparency in corporate disclosure and reporting to align them with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) through the introduction of a new Corporate Sustainability Reporting Directive.30

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In December 2019, the European Commission published the ‘European Green Deal’, setting out plans for the European Union to achieve net zero greenhouse gas emissions by 2050.31 To support a sustainable recovery from the Covid-19 pandemic, in 2020 and 2021 the European Green Deal was developed further in eight key policy areas based on an inclusive green transition: biodiversity, sustainable food systems, sustainable agriculture, clean energy, sustainable industry, building and renovating, sustainable mobility, eliminating pollution and climate action. The EU has also adopted a more ambitious intermediate step of reducing emissions by at least 55 per cent from 1990 levels by 2030. The European Commission estimates the cost of the European Green Deal at approximately €1 trillion over a 10-year period, of which 30 per cent will be raised through the issue of green bonds.32 The publication of the EU Taxonomy, and the development and approval of new ‘green’ financial products and services, are seen as key enabling steps to unlock the substantial private sector investment required to support the European Green Deal.

The EU Taxonomy for Sustainable Activities The EU Taxonomy for Sustainable Activities, generally referred to as the ‘EU Taxonomy’, was published in June 2020, as noted previously. The Taxonomy provides an important foundation for green and sustainable finance in the EU, and for others wishing to undertake financial activities within/with the EU. It does so by defining what economic activities and assets can be described as ‘green’ and ‘sustainable’. The Taxonomy is a classification system that lists sustainable economic activities that make a substantive contribution to one or more of six environmental objectives, without detracting from any of the others, as set out in Table 3.1. Table 3.1  The EU Taxonomy – environmental objectives Activity

Description (abridged)

Climate change mitigation

The activity contributes to greenhouse gas stabilization consistent with the goals of the Paris Agreement.

Climate change adaptation

The activity includes adaptation solutions that substantially reduce the adverse impact (or risk) of the current and expected future climate on (i) other people, nature or assets; or (ii) the economic activity itself.

Sustainable use and protection of water and marine resources

The activity substantially contributes to achieving the good condition of water bodies or marine resources, or to preventing their deterioration when their condition is already good. (continued )

Building a sustainable finance system

Table 3.1  (Continued) Activity

Description (abridged)

Transition to a circular economy

The economic activity contributes substantially to waste prevention, re-use and recycling.

Pollution prevention and control

The activity contributes substantially to pollution prevention and control by preventing or, where that is not practicable, reducing pollutant emissions (other than GHGs) into air, water or land).

Protection and restoration

The activity contributes substantially to protecting, conserving or restoring biodiversity and to achieving the good condition of ecosystems, or to protecting ecosystems that are already in good condition.

SOURCE  European Commission (2020) Sustainable Finance Taxonomy – Regulation (EU) 2020/852, https://ec.europa.eu/info/law/sustainable-finance-taxonomy-regulation-eu-2020-852_en

Activities must also comply with the following criteria to be considered sustainable: ●● ●●

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They must not significantly harm any of the six environmental objectives. They must comply with minimum performance thresholds (the ‘Technical Screening Criteria’) for the relevant environmental objective (see below). They must be carried out in compliance with a number of minimum social and governance safeguards referred to in the EU Taxonomy Regulation.33

More granular detail is required, however, to make the Taxonomy meaningful and useful for decision making. The EU is developing detailed Technical Screening Criteria for each environmental objective, therefore, setting out a more specific range of economic activities under each objective, listing minimum performance thresholds, and describing how emissions and other key metrics should be calculated and how a ‘no significant harm’ assessment should be conducted.34 The EU Taxonomy has been criticized by some, partly because it was felt that some of the detailed criteria used were not sufficiently science-based, and partly because of the involvement in its development of experts representing high-carbon sectors and of financial institutions financing these. The late inclusion of nuclear and gas power generation as (under certain circumstances) sustainable economic activities following their exclusion by the High-Level Expert Group has also led to significant criticism and accusations of greenwashing and undue influence from lobbying. Despite these criticisms, the EU Taxonomy remains a key foundation for green and sustainable finance in the EU and beyond; other countries are developing similar taxonomies modelled on the EU’s approach, and/or are seeking to harmonize their approaches with that of the EU.

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READING Public criticism of the European Commission’s decision to include gas and nuclear power in the EU Taxonomy for Sustainable Activities35 Responding to the European Commission’s Decision to include gas and nuclear power in the EU Taxonomy for Sustainable Activities, in March 2022 a large group of more than 90 NGOs, led by Reclaim Finance, Friends of the Earth and Greenpeace, published an open letter aimed at the boards and senior management of financial institutions. The text of the letter is set out below. Dear banks, investors, and insurers, On February 2nd, 2022, the European Commission proposed the inclusion of fossil gas and nuclear in the EU sustainable taxonomy. This decision concludes a two-year saga that transformed a ‘science-based’ framework aimed at channelling investment towards sustainable activities into a highly politicized document that bends to the views of fossil gas and nuclear supporters. This decision is unscientific and unjust, and responsible financial institutions must publicly commit to exclude fossil gas and nuclear energy from any of their products and bonds marketed as sustainable, green, or responsible. Both fossil gas and nuclear were excluded from the taxonomy in the final report of the expert group appointed by the EU Commission. The reasons for this exclusion were simple: gas power generation has significant GHG emissions, and there is still no proven sustainable solution for disposing of nuclear waste. However, gas and nuclear lobbyists and European member states with important stakes in these industries disagreed, and the EU Commission deliberately allowed new fossil gas plants and nuclear power plants to be included in the EU Taxonomy. Indeed, fossil gas and nuclear were so far the only two activities to benefit from a specific process. Nuclear energy was submitted to a review by the Joint Research Committee of the EU Commission, a group with ties to the nuclear industry, which painted the waste disposal problem as solved. It did not consider the possibility of accidents and failed to account for the environmental risks in the supply chain for uranium. Gas was allowed to depart from the GHG emission threshold for power generation and/or heat production and can emit three times more than other production methods included in the taxonomy. The choice to include fossil gas and nuclear in the EU taxonomy disregards the numerous warnings from scientists, NGOs and CSOs that such a decision would endanger the EU’s sustainable transition. On the one hand, new taxonomy-compliant gas power plants releasing 270 gCO2e/kWh would already emit more GHG than the

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current average carbon intensity of EU electricity production and 16 to 38 times the emissions of onshore wind power, therefore blocking the EU power system from reaching carbon neutrality for decades. On the other, nuclear waste still poses major sustainability problems. In addition, new nuclear reactors will take a long time to start producing electricity, thus requiring the extension of fossil fuel power plants. Both nuclear energy and gas combustion further come with negative impacts on water availability and quality. By including fossil gas and nuclear in the EU taxonomy after a non-transparent process, the Commission undoes four years of work by EU institutions and expert groups and damages the EU’s sustainable finance flagship. The EU’s own Platform on Sustainable Finance, as well as many sustainable finance professionals and groups including the European organization Eurosif and the UN Principles for Responsible Investment, have opposed the Commission’s proposal to include fossil gas and nuclear, and underlined it would both sap the confidence in the new framework and have detrimental environmental impacts. The EIB President indicated that the European bank will apply its own – more stringent – criteria. The European Consumers’ Association (BEUC) summarized this by denouncing ‘unacceptable institutional greenwashing’. This position is shared by many of those who will be the prime users of the taxonomy: financial institutions. The IIGCC – an investor group made up of more than 370 institutions and with more than $50 trillion of assets under management – opposed the inclusion of fossil gas, saying that it would ‘undermine the credibility of the taxonomy as well as the EU’s own commitment to climate neutrality by 2050’. Several individual financial institutions took similar positions on gas and/or nuclear, like Mirova in France, Achmea or ABP in the Netherlands, Union Investment or GLS in Germany and Raiffeisen Bank International in Austria. The responsibility now lies with financial institutions not to mislead their clients. Even if the delegated act requires financial institutions to report their support to fossil gas and/or nuclear separately, Europeans have the right to expect that the sustainable products they are sold do not support fossil gas and nuclear and must not have to verify this themselves. The existing global green bond market excludes fossil fuels and nuclear power, similarly to several green retail finance labels in European countries: the EU taxonomy must not be a pretext to go backwards. We, NGOs and CSOs ask financial institutions to publicly commit to exclude both fossil gas and nuclear from all their products and bonds marketed as sustainable, green, or responsible. This notably entails excluding these energies from ‘Article 9’ funds. Europeans must not be deceived into believing they are supporting the sustainable transition by opting for a climate-aligned taxonomy while unknowingly supporting fossil gas and nuclear development instead.

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QUICK QUESTION What do you think? Should gas and/or nuclear power be included in the EU taxonomy?

European Financial Regulators Key European financial regulatory bodies are addressing climate change, and seeking to promote and develop green and sustainable finance. For example: ●●

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The European Central Bank (ECB) published supervisory guidance in May 2020 setting out its expectations of European financial institutions relating to the identification, disclosure and management of climate-related and environmental risks.36 It expects financial institutions to consider these as part of their overall approach to risk management, and when formulating and implementing their business strategies. The ECB’s guidance is examined in more detail in Chapter 8. In March 2022, the ECB published an assessment of the progress made by European banks in disclosing these risks37 and plans to conduct climate risk stress testing on banks in 2022. The European Banking Authority (EBA) published its Action Plan on Sustainable Finance in 2019.38 This aimed to provide clarity to financial institutions on the EBA’s high-level policy direction and expectations on the management of climate and environmental risks. In 2021, the EBA published proposals for integrating what it terms ‘ESG factors’ and ‘ESG risks’ into its regulatory and supervisory framework.39 Its proposals include recommendations for institutions to incorporate consideration of ESG risks into their governance structures, decision making and risk management, and to use scenario analysis to support longer-term resilience planning. The European Securities and Markets Authority (ESMA) set out its Strategy for Sustainable Finance in 2020. Key priorities include transparency, risk analysis of green bonds, ESG investing, convergence of national supervisory practices relating to sustainability and the EU Taxonomy.40 ESMA is currently implementing the Sustainable Finance Disclosures Regulation (SFDR) introduced above, and examined in more detail in Chapter 9.41 The European Insurance and Occupational Pensions Authority (EIOPA) aims to ensure that insurers, reinsurers and occupational pension funds integrate sustainability risks into their risk management to protect consumers and financial stability, setting out its priorities for the period 2022–24 in a new sustainable finance strategy.42 In 2020, EIOPA released its first analysis of the sensitivity of insurers’

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balance sheets to climate-related financial risks, including the transition to a lowcarbon economy,43 and in 2022 it will conduct its first climate risk stress tests on occupational pension providers.44

Selected national policy responses Below are some examples of measures taken to address climate, environmental and other sustainability risks, and to support the growth of green and sustainable finance adopted by selected G20 countries: ●●

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Brazil: The Banco Central do Brasil (BCB) launched a new Sustainability Agenda in 2020, encompassing the disclosure, management and supervision of climate and environmental risks in line with the TCFD’s recommendations, and the promotion of sustainable finance.45 In the same year, the Brazilian Business Council for Sustainable Development launched the Green Finance Initiative,46 and the Brazilian Association of Development and the Inter-American Development Bank established a Financial Innovation Laboratory to support innovation and growth in the green bond, sustainable FinTech and impact investing sectors.47 China: Chinese President Xi Jinping and the State Council have made developing and implementing a green finance system for China a national priority, supporting China’s objective of becoming carbon neutral by 2060, as set out in the case study at the beginning of this chapter. A Green Bond Endorsed Project Catalogue, published in 2020 and revised in 2021, classifies environmentally sustainable activities in a similar manner to the EU Taxonomy, and forms a basis for defining ‘green’ and ‘sustainable’ financing activities (the Catalogue is examined in Chapter 8 in more detail). The People’s Bank of China (central bank) has introduced a wide series of policy measures to address climate risks, including mandatory disclosure requirements and climate stress testing for banks.48 As we will explore in Chapter 5, China launched an emissions trading scheme in 2021, initially targeted at more than 2,000 coal, gas and other power-generation plants, and to be rolled out to other high-emissions sectors in future years. France: Green finance has been a priority for policymakers and regulators in France, with the Banque de France (the central bank) playing a key role in establishing and hosting the Network for Greening the Financial System. In 2015, the French government introduced a law on ‘Energy Transition and Green Growth’. Article 173 required major institutional investors to report how they take ESG factors into account in their investment decision making – France was one of the first countries to make such disclosures mandatory, although these have now been overtaken by the EU’s TCFD-aligned reporting requirements described above. In 2021, France introduced rules requiring financial institutions to set greenhouse gas

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emissions targets for every five-year period until 2050, and to set targets to protect biodiversity, too. ●●

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Germany: In 2019, a Sustainable Finance Committee was established to develop a national Sustainable Finance Strategy, published in 2021, with the overall objective of establishing Germany as a leading global centre for sustainable finance. The strategy sets out 26 specific measures grouped into five themes: promoting sustainable finance at the European and global levels; financing transition; improving the disclosure and management of climate, environmental and sustainability risks; building capacity and capability; and establishing the German government as a role model (e.g. via the issue of sovereign green bonds).49 A major role is played by the German national development bank (Kreditanstalt für Wiederaufbau, KfW), which funds climate change mitigation and adaptation activities in Germany and internationally, and works with commercial banks to help them promote sustainability. The role of the KfW (and other development banks) is examined in more detail in Chapter 8. Singapore: In 2020, the Monetary Authority of Singapore (MAS) published a Green Finance Action Plan with the aim of establishing Singapore as a leading Asian and global green finance centre. The Plan has four key strategies: to strengthen financial sector resilience through enhanced disclosure and management of climate and environmental risks; to support the development of sustainable financial markets and products; to develop digital solutions to support sustainable finance (see Chapter 11 for more details); and to build knowledge and capabilities to support the growth of the green and sustainable finance sector.50 As part of this last strategy, the MAS and the Institute of Banking and Finance Singapore (IBF) have developed a Sustainable Finance Technical Skills and Competencies Framework, setting out 12 thematic areas which, in their view, will give finance professionals a broad understanding of sustainability issues.51 South Africa: In 2017, the National Treasury convened a Working Group of financial regulators and industry associations, now the South Africa Sustainable Finance Initiative,52 to develop a national framework for sustainable finance. Key objectives were set out in a 2020 report, ‘Financing a Sustainable Economy’, including the development of a Green Finance Taxonomy, establishing standards and guidance for financial institutions on climate risk management and disclosures, target-setting, and building capacity and capabilities to support the growth of sustainable finance in South Africa and beyond.53 In March 2022, the South African Green Finance Taxonomy was published, which defines assets, projects, activities and sectors eligible to be defined as ‘green’ in line with international best practice and national priorities.54

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United States: Following the election of President Biden in November 2020, the United States rejoined the Paris Agreement and regulators have begun to prioritize the disclosure and management of climate risks. The Department of the Treasury has created a new Climate Hub to coordinate efforts to tackle climate change and increase climate finance, and the US Federal Reserve has become a member of the Network for Greening the Financial System. Several US regulators have published rules on climate risk disclosures (see Chapter 5), including the Securities and Exchange Commission’s (SEC) Climate Disclosure Rule, which would require US public companies to report on climate risks in line with the TCFD’s recommendations.55 As we will explore in Chapter 7, US organizations are one of the leading issuers of green bonds (and have been for some years).

QUICK QUESTION What measures to encourage the growth of green and sustainable finance are you aware of in the country where you live and/or work?

CASE STUDY Sustainable finance developments in Japan As the third-largest contributor of funds to the United Nations, Japan has ambitions to lead the global green revolution. By January 2020, 78 large Japanese investment funds and financial institutions had signed up to the Principles for Responsible Investment. This, however, contrasts sharply with the fact that Japanese banks are amongst the major financers of coal mining and power generation, particularly in developing countries. Following the 2011 Fukushima Daiichi nuclear power disaster, Japan underwent several structural changes and regulatory shifts to help boost sustainable energy. These have had little effect, however. For example, the Japanese carbon tax is amongst the lowest in the world at just $5 per tonne of carbon emissions (2020). Japan’s policies on sustainability mostly derive from the Basic Environment Law of 1993. This is reviewed and updated at least every six years. In 2018, the Japanese government adopted the Fifth Basic Environment Plan, which set out six major goals for future environmental policy: 1 Create a green economic system to support sustainable production and consumption.

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2 Improve the quality of national land. 3 Use local resources to develop a sustainable community. 4 Realize healthy and prosperous lives. 5 Develop and disseminate technology that supports sustainability. 6 Demonstrate leadership through international contributions and by building strategic partnerships. In recent years, Japan has made significant strides in terms of green and sustainable finance. In 2018 the Ministry of the Environment issued a key report, ‘Towards Becoming a Big Power in ESG Finance’.56 In addition, Japan has formed/joined a number of finance groups, including: ●●

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the Network for Greening the Financial System (NGFS) – a group of central banks and regulators that share experience and best practices to develop climate risk management; the Green Finance Network Japan, launched in 2018 – a symposium for green finance in both the public and private sectors in Japan; and the Japanese Financial Services Agency’s (JFSA) Expert Panel on Sustainable Finance’, launched in December 2020 – the panel will discuss future policies for green and sustainable finance to enable Japan to achieve its goal of net zero by 2050.57

Finance sector initiatives to support the growth of green and sustainable finance As outlined in Chapter 1, while estimates of the total cost of financing the transition to a sustainable, low-carbon world vary, a figure of $6 trillion per year is plausible, and is the one we use throughout this book. It is widely agreed that public funds will be insufficient to finance the transformation, and that substantial amounts of private capital are needed, estimated at up to 80 per cent of the total. In response to policy signals, regulatory pressures, a growing appreciation of the true costs of climate change and changing customer, client and investor demands, many financial institutions are aligning their strategies, activities and decision making with the objectives of the Paris Agreement and other sustainability goals. Tackling the global, collective challenge of climate change requires a global, collective response from the finance sector, coordinated and led by initiatives including the Principles

Building a sustainable finance system

for Responsible Investment, Responsible Banking and Sustainable Insurance, and GFANZ/the UN-convened Net Zero Alliances described above. There are also a growing range of international finance sector coalitions, networks and initiatives to develop, disseminate and embed green and sustainable finance principles that can help align the finance sector overall, and institutions’ strategies, activities and operations, with sustainable objectives. Such principles can – and must – become norms that guide behaviour and decision making, and shape strategies for green and sustainable finance that can then be put into practice. Some of the key international principles green and sustainable finance professionals should be aware of are outlined in the following section (and expanded on in later chapters), along with some other key private sector initiatives to align finance and sustainability.

QUICK QUESTION What finance sector initiatives are you aware of that you associate with green and sustainable finance? Which of the below are most relevant to the organization you work for, or the country/region where you live and work?

Banking sector initiatives Equator Principles Established in 2003, the Equator Principles comprise a voluntary code of conduct and a risk management framework for determining, assessing, managing and reporting on environmental and social risks in major projects, such as in energy or infrastructure. The Principles themselves are designed to be applied in the context of project finance with capital costs in excess of $10 million, but institutions can (and do) apply them more widely to other aspects of their financing operations. The Principles have been regularly updated since their launch, with the current (fourth) revision, known as EP4, released in 2020. As of 2022, nearly 130 major financial institutions in 38 countries had officially adopted the Principles. Signatories are required to report annually on their implementation of the Principles, with reports available in the public domain. For more information, see https://equator-principles.com

Green, Sustainability and Social Bond Principles The Green Bond Principles (GBP) are voluntary process guidelines that recommend transparency and disclosure and promote integrity in the development of the green

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bond market.58 Established by the International Capital Market Association (ICMA), and revised in 2021, they: ●●

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provide guidance for issuers on the key components involved in launching a credible green bond; aid investors by ensuring the availability of information necessary to evaluate the environmental impact of their green bond investments; and assist underwriters by moving the market towards standard disclosures to facilitate transactions.

The ICMA publishes similar principles and guidelines for other bond categories – sustainability bonds, sustainability-linked bonds and social bonds – collectively known as ‘the Principles’.59 We discuss the Principles, and other market standards and guidelines to support the development of the green and sustainable bond sector, in more detail in Chapter 7. For more information, see www.icmagroup.org/sustainable-finance/the-­principlesguidelines-and-handbooks/

Climate Bonds Initiative The Climate Bonds Initiative (CBI) is an international, not-for-profit organization working to mobilize the global bond market for climate change solutions. It aims to promote investment in projects and assets necessary for a rapid transition to a lowcarbon and climate-resilient economy. A Climate Bonds Standard and a supporting certification scheme have been developed to bring consistency to relevant bond issues, including clarity over ‘green’ project outcomes and use of proceeds. We describe the Standard in more detail in Chapter 7. The CBI also provides a wide range of resources to support the continued development of the green and climate bond markets, including tracking issuance (we use the CBI’s figures throughout this book). Through its activities, the CBI aims to develop large, liquid climate and green bond markets that will drive down the cost of capital for climate change mitigation and adaptation projects in developed and emerging markets, mobilizing what they describe as a $100 trillion bond market for climate change solutions. For more information, see https://www.climatebonds.net

Green Loan Principles Launched in March 2018 and updated in 2021, the Green Loan Principles (GLPs) provide a framework and standards for green lending by institutions, designed to promote global consistency in the application and reporting of green loans.60 They

Building a sustainable finance system

aim to ensure consistency in the use of the term ‘green loan’ to maintain the integrity and support the growth of the green loan market, and to prevent instances and accusations of greenwashing. The GLPs were developed by the Loan Syndications and Trading Association (LSTA) and other bodies primarily for the syndicated loan market, but have broad applicability across most, if not all, types of corporate lending, and are being widely applied. Building on the Green Loan Principles, Social Loan Principles61 (SLPs) and Sustainability Linked Loan Principles62 (SLLPs) have also been developed. The SLPs closely mirror the GLPs in their approach but, as the name suggests, do so in the context of social sustainability (‘lending for social purposes’) rather than environmental sustainability. The SLLPs aim to bring greater consistency to the market for sustainability-linked loans by providing guidance on defining appropriate sustainability performance targets (SPTs), measured by predefined key performance indicators (KPIs). The GLPs, SLPs and SLLPs are explored in more detail in Chapter 6. For more information, see www.lsta.org/content/green-loan-principles/

Sustainable Banking and Finance Network The Sustainable Banking and Finance Network (SBFN) is a voluntary community of more than 70 financial regulators and banking associations from (mainly) 47 emerging markets, committed to advancing sustainable finance in line with international good practice. The Network facilitates the collective learning of members and supports them in policy development and related initiatives to create drivers for sustainable finance in their home countries. Member countries represent more than 85 per cent of total banking assets in emerging markets. The SBFN publishes regular progress reports setting out details of collective and national progress made in developing action plans, policies, guidelines, principles and roadmaps to support the growth of green and sustainable finance in emerging markets, and to build the capacity and capabilities required to support this. The most recent report (2021) notes that particular progress has been made in the areas of ESG integration, climate risk management and financing sustainability through the launch of green and other types of bonds and loans, and the development of taxonomies and similar measures.63 For more information, see https://www.sbfnetwork.org

Global Alliance for Banking on Values The Global Alliance for Banking on Values (GABV) is an international network of banks and supporting partners that describe themselves (with good reason) as pioneers in using finance to serve people and the planet. The GABV describes its collective goal as being to make the banking system more transparent and to support positive economic, social and environmental change. The GABV has published six

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Principles of Values-Based Banking to support its members’ focus on serving human needs and ensuring environmental, social, economic and financial sustainability.64 As of 2022, the GABV comprises 66 members in 44 countries; these are mainly smaller and more specialist financial institutions including, but not limited to, banking cooperatives, credit unions, microfinance institutions and community development banks. For more information, see https://www.gabv.org

Investment sector initiatives Net Zero Asset Managers Initiative Established in 2020, the Net Zero Asset Managers Initiative brings together more than 200 asset managers with nearly $60 trillion of assets under management. In a manner similar to that of the UN-convened Net Zero Alliances introduced above, members commit to working with asset managers to align investments with net zero greenhouse gas emissions by 2050 and to set interim targets towards that goal. The Initiative is not convened by the UN, but rather governed by six global and regional investor networks: the Asia Investor Group on Climate Change (AIGCC), CDP Global, Ceres, the Institutional Investors Group on Climate Change (IIGCC), the Investor Group on Climate Change (IGCC) and the PRI. It is aligned to GFANZ and is a partner of the UNFCCC’s Race to Zero Campaign. For more information, see https://www.netzeroassetmanagers.org/#

Paris Aligned Investment Initiative The Paris Aligned Investment Initiative is an investor-led global forum encompassing some 120 investors representing $34 trillion in assets. Originally established in 2019 by the Institutional Investors Group on Climate Change (see below), it is now supported by four regional investor networks that also oversee the Net Zero Asset Managers Initiative – AIGCC (Asia), Ceres (North America), IIGCC (Europe) and IGCC (Australasia). The Initiative supports investors in applying the Net Zero Investment Framework, which sets out pathways for investors to decarbonize investment portfolios and increase investment in climate solutions aligned with 1.5°C of global warming above pre-industrial levels. Like the Net Zero Asset Managers Initiative outlined above, the Paris Aligned Investment Initiative is aligned to GFANZ and is a partner of the UNFCCC’s Race to Zero Campaign. For more information, see https://www.parisalignedinvestment.org

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Institutional Investors Group on Climate Change The Institutional Investors Group on Climate Change (IIGCC) is the European forum for large investors to collaborate on climate change, providing them with a collaborative platform to encourage public policies, investment practices and corporate behaviour that address long-term risks and opportunities associated with climate change. As of 2022, the IIGCC has more than 370 members from 22 countries representing over €50 trillion in assets. As noted above, the IIGCC, together with similar regional bodies in Asia (AIGCC), Australasia (IGCC) and North America (Ceres), has helped establish and convene a range of initiatives to tackle climate change and align the investor community with sustainability. For more information, see https://www.iigcc.org/

Climate Action 100+ Climate Action 100+ is an initiative led by institutional investors to engage systemically important greenhouse gas emitters that can drive the clean energy transition to achieve the goals of the Paris Agreement. The 615 members of the initiative (as of 2022) engage with nearly 170 large companies responsible for an estimated 80 per cent of global industrial emissions to improve governance on climate change and sustainability, strengthen climate-related financial disclosures, reduce emissions and help them transition to more sustainable, low-carbon business models. Climate Action 100+ members seek commitments from boards and senior management to: ●●

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implement a strong governance framework which clearly articulates the board’s accountability and oversight of climate risk; take action to reduce greenhouse gas emissions across the value chain, consistent with the Paris Agreement’s goal of limiting global average temperature increase to well below 2°C above pre-industrial levels, and ideally 1.5°C; and provide enhanced corporate disclosures in line with the TCFD’s recommendations.

For more information, see http://www.climateaction100.org and the case study in Chapter 9.

Global Sustainable Investment Alliance The Global Sustainable Investment Alliance (GSIA) is a coalition of membershipbased sustainable investment organizations around the world with a mission to increase the impact and visibility of its members at global level. Members of the GSIA include the UK Sustainable Investment and Finance Association (UKSIF), the European Sustainable Investment Forum (Eurosif), the Responsible Investment

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Association Canada (RIA Canada), the US Forum for Sustainable and Responsible Investment (US SIF), the Responsible Investment Association Australasia (RIAA) and the Dutch Association of Investors for Sustainable Development (VBDO). The GSIA publishes a biennial Global Sustainable Investment Review, which monitors the growth of sustainable and responsible investment in major global financial markets including the United States, Canada, Japan, Australasia and Europe. For more information, see http://www.gsi-alliance.org/

Global Impact Investing Network The Global Impact Investing Network (GIIN) is a global community of more than 360 asset owners, investors and service providers dedicated to accelerating the practice of impact investing (we explore the definition and practice of impact investing in Chapter 9). GIIN undertakes a wide range of research and market leadership initiatives, and convenes and supports several global and regional impact investing networks. GIIN has a particular focus on measuring impact management to support more informed impact investment decision making. It has developed a free, publicly available IRIS+ system to facilitate this (IRIS+ is examined in more detail in Chapter 4). For more information, see https://thegiin.org/

Insurance sector initiatives As major institutional investors and asset owners, insurers are involved in many of the UN-convened and other investor initiatives introduced above. In addition to these, and to the Principles for Sustainable Insurance, several coalitions and networks have been established for insurers and reinsurers seeking to address climate, environmental and other sustainability risks, and to align their strategies and objectives with the goals of the Paris Agreement and wider sustainability objectives. They include:

Sustainable Insurance Forum Established in 2016, the Sustainable Insurance Forum (SIF) is an international network of 33 insurance regulators and supervisors overseeing more than 90 per cent of the global insurance market and $5 trillion in premiums. The SIF works in several areas, including to ensure that insurers can accurately price and manage climate risks, to address the climate risk protection gap (the divide between economic and insured losses due to climate change), to address the impacts of wider environmental risks (such as biodiversity loss) on the insurance sector and to incorporate climate risks into actuarial processes. Aspects of the SIF’s work are examined in more detail in Chapter 10. For more information, see https://www.sustainableinsuranceforum.org/

Building a sustainable finance system

ClimateWise ClimateWise is a global network of leading insurance industry organizations, convened by the University of Cambridge Institute for Sustainability Leadership (CISL). It aims to help the insurance sector to better communicate, disclose and respond to the risks and opportunities of climate change. It has developed the ClimateWise Principles65 to guide members’ transition to sustainable, low-carbon practices and to coordinate the sector’s response to the climate risk protection gap. First developed in 2007, the Principles have been revised to align with the TCFD’s recommendations. For more information, see https://www.cisl.cam.ac.uk/business-action/sustainablefinance/climatewise

InsuResilience Global Partnership The InsuResilience Global Partnership was launched at COP23 in 2017 and consists of more than 100 governmental, civil society and insurance sector partners. It aims to increase the climate resilience of the world’s poorest and most vulnerable people – many of whom are those most impacted by climate change – by providing direct insurance (where individuals or small businesses insure themselves) or indirect insurance (where governments take out the insurance) against climate risks, including extreme weather events. For more information, see https://www.insuresilience.org/

Other International Network of Financial Centres for Sustainability Founded in 2017, the International Network of Financial Centres for Sustainability (usually referred to as FC4S) is a collective of some 40 major financial centres representing more than 80 per cent of global equity markets working together to achieve the objectives of the Paris Agreement and the UN Sustainable Development Goals. FC4S has developed a Sustainability Alignment Scale, which members and others can use to assess the extent of their alignment. Level 0 indicates that a centre has little or no awareness of climate change and sustainability, Level 5 that the centre is aligned with the Paris Agreement and the UN SDGs. Over time, through peer pressure, sharing best practice between members and building their capacity and capabilities, financial centres should increase their level on the scale. For more information, see https://www.fc4s.org

Sustainable Stock Exchanges Initiative The SSE Initiative is a UN Partnership Programme organized by UNCTAD, the UN Global Compact, UNEP FI and the PRI. It provides a global platform for exchanges

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and their participants (e.g. investors, issuers and regulators) to collaborate to address climate change, gender diversity and other sustainability issues, and to encourage the growth of sustainable investment, including the financing of the UN Sustainable Development Goals. The more than 100 members encompass the great majority of exchanges worldwide. The SSE is a voluntary initiative, with exchanges asked to make a non-binding commitment to advancing sustainability in their market. It seeks to make progress via a programme of research and dissemination, facilitating a network and forum for multi-stakeholder consensus-building and the sharing of good practice, and providing technical assistance and advisory services to exchanges. For more information, see https://sseinitiative.org/about/

Net Zero Financial Services Providers Alliance The Net Zero Financial Service Providers Alliance (NZFSPA) is a global group of service providers supporting the finance sector, including, but not limited to, auditors, consultancies, data providers, index providers and rating agencies. Members commit to align their relevant products and services with net zero greenhouse gas emissions by 2050, and to set interim targets aligned with the goals of the Paris Agreement. The NZFSPA is aligned with GFANZ and is a partner of the UNFCCC’s Race to Zero Campaign. For more information, see https://www.netzeroserviceproviders.com

Net Zero Investment Consultants Initiative In September 2021, the 12 founding members of the Net Zero Investment Consultants Initiative (NZICI) launched a commitment to integrate advice on net zero alignment into all their investment consulting services, helping their clients achieve net zero greenhouse gas emissions by 2050 in accordance with the goals of the Paris Agreement. The NZICI aims to grow its membership and work with investor groups including the PRI, Net Zero Asset Owner Alliance and Net Zero Asset Manager Initiative, and other groups that the PRI works with on this important issue, and to become a GFANZ member and partner of the UNFCCC’s Race to Zero Campaign. For more information, see www.unpri.org/climate-change/leading-investmentconsultants-form-global-initiative-to-push-for-net-zero/8549.article

Institutional responses – embedding sustainability into strategy In this chapter we have introduced many of the most important intergovernmental and national policy and regulatory measures and finance sector initiatives seeking to

Building a sustainable finance system

address climate change and accelerate the growth of green and sustainable finance. To be truly effective in aligning finance and sustainability, however, international, national and industry frameworks, principles and initiatives need to be translated into meaningful action by the finance sector. This will require banks, insurers, investors and other organizations to embed green and sustainable finance principles and practice into their strategies, operations and activities so that – as set out by Mark Carney in the COP26 Private Finance Strategy – ‘… every financial decision takes climate change into account’.66 Whilst every competent organization has a strategy, sustainability may not at present be incorporated in the development and implementation of organizational strategy in terms of: ●●

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how climate change and broader environmental and social sustainability factors will impact the demand for the organization’s products and services, creating both challenges and opportunities; how climate change and broader sustainability factors will affect the organization’s operations, including impacts through its supply chain, and its ability to recruit, retain and motivate the staff it needs to support its activities; the impact of the organization’s chosen strategy, as expressed through its products, services and operations, on the environment, and on society more broadly; the organization’s ability to attract the financing it needs, and the cost of that financing; and the long-term impact on desired financial and other returns to owners, investors, employees and other stakeholders.

‘Light green’ strategies and ‘greenwashing’ ‘Light green’ strategies are those in which green and sustainability factors are not central to an organization’s strategy and operations. They serve as additions to a strategy that does not have a green and sustainable vision and purpose at its core. Whilst organizations may display genuine and well-intentioned commitments to avoiding harmful activities and supporting the transition to a low-carbon world, in practice such commitments may not always be embedded within their purpose and strategy. In some cases, commitments may prove to be little more than marketing-led activities that make organizations appear greener than they are in practice. The following examples illustrate what might be considered as ‘light green’ strategies: ●●

An energy company creates a new green strategy focusing on their administrative processes, such as encouraging greater energy efficiency and recycling in company

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offices and increasing their use of videoconferencing rather than flying to internal and client meetings. Their central business operations are untouched and rely on fossil fuel CO2-intensive extraction. ●●

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A $1 billion investment fund announces that they will invest $100 million in renewable technologies. The rest of their investment portfolio remains untouched, including investments in high-carbon sectors and firms. A no-frills airline enables passengers to pay for a voluntary carbon offsetting scheme whilst increasing its expenditure on fuel to serve expanding flight operations. A fossil fuel company issues a green bond to demonstrate its green credentials and the steps it is taking to support the transition to a low-carbon economy. An oil company highlights its investments in carbon capture and storage (CCS) research to imply that this makes oil consumption compatible with meeting climate change commitments. A fast-food chain, which sources meat and materials from companies that contribute to deforestation in the Amazon, announces that its plastic drinks bottles are recyclable.

Light green strategies, particularly those that are marketing-led and designed to give a misleading impression of an organization’s commitment to green and sustainable operations, can lead to charges of ‘greenwashing’. This is a term introduced in Chapter 1 and defined there as ‘inadvertently or deliberately misleading others about the environmental or broader sustainability benefits of an activity, project, product or service’. In the context of strategy, greenwashing indicates that organizations are giving the illusion of supporting green and sustainable principles whilst not fundamentally adapting or changing their activities, behaviour and culture. In the organizational context, there are two general types of greenwashing: 1 When the efforts of a company to be ‘green’ make a small, positive difference, but that contribution is insignificant relative to the harm or damage caused by the company’s core activities, as exemplified by the examples of the energy company and fast-food chain above. 2 When the efforts of a company to be ‘green’ and ‘sustainable’ are not green at all and make no difference to (or may actively harm) the environment, for example when a ‘green’ bond is used to finance slightly cleaner coal power. Central to understanding whether or not an activity is really ‘green’ and ‘sustainable’ is considering whether it has a genuinely positive and additional impact on the environment and/or society, and whether that impact would have occurred anyway without that activity taking place. This is where initiatives such as the EU and other taxonomies are key, as they provide a basis for a common understanding of whether an activity is ‘green’ and ‘sustainable’, or not.

Building a sustainable finance system

Greenwashing is a real risk to the long-term viability of green and sustainable finance, and to the development of green products and services in finance (and to the transition to a sustainable, low-carbon world in general). If investors, lenders and consumers lack confidence in the integrity of organizations, activities, products and services labelled as ‘green’ and ‘sustainable’, then organizational and individual behaviour is unlikely to shift at the pace needed to achieve net zero by mid-century in line with the objectives of the Paris Agreement. This is a particular concern in the retail investment market, given the rapid growth of funds labelled as ‘green’, ‘sustainable’, ‘ESG’ and similar, as we discuss in Chapter 9. One high-profile example of greenwashing was the Volkswagen diesel emissionstesting scandal, exposed in 2015.67 Software embedded in engine management systems was used to detect and ‘cheat’ emissions tests to make Volkswagen’s cars appear more environmentally friendly than they were. In this example, apparently the greenwashing was intentional; in other cases, it may occur inadvertently, but the long-term impacts on consumer confidence and investor sentiment remain the same.

QUICK QUESTION Have you come across examples of greenwashing in the products and services you consume or have read about? Has this affected your impression of the manufacturer/provider, and has it altered your buying behaviour?

Intergovernmental bodies such as the UN and the EU, national governments and finance sector initiatives all play important roles in identifying green and sustainable products, services and activities. They do this by developing and enforcing: ●●

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classifications – for example the Green Bond Principles and Climate Bonds Standard; taxonomies – for example the EU Taxonomy for Sustainable Activities; regulations – to ensure investments are appropriately described, and not mis-sold (explored in Chapter 9); and labelling systems – such as that proposed in the EU for investment funds (also explored further in Chapter 9).

These can bring consistency to the market and enhance investor and consumer confidence but are – in many cases – still in development or are voluntary. At present, civil society organizations (particularly environmental NGOs) and individual activists play key roles in preventing greenwashing. They do this by identifying and ‘naming and shaming’ organizations, activities, products and services that could be accused

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of greenwashing, and in some cases organizing campaigns and boycotts against companies – examples include Ethical Consumer68 and Truth in Advertising.69 In Chapter 4 we will examine monitoring, evaluation and verification practices in green and sustainable finance to see how these can help prevent greenwashing, provide greater certainty to investors and consumers, and ensure the integrity of the green and sustainable finance market. As we shall see in Chapter 12, individual green and sustainable finance professionals also have an important role to play in ensuring market integrity, with a moral and professional duty to be honest with themselves and with customers and colleagues about the genuine or other nature of products and services labelled as ‘green’ and/or ‘sustainable’. Green and sustainable finance professionals should actively avoid being involved in ‘greenwashing’, whether intentional or inadvertent. They must take active steps to be assured about the genuine green and sustainable credentials of organizations, activities, products and services, and must not overstate the benefits of, or avoid disclosing harm caused by, these.

‘Deep green’ strategies In contrast to light green strategies, ‘deep green’ strategies are those in which green and sustainable principles and practices are fully embedded in and direct the strategy and operations of an organization. An organization with a deep green strategy aligns its vision, purpose and culture with mitigating the effects of climate change and supporting the transition to a sustainable, low-carbon world. These may be the main drivers of an organization’s strategy or may form an important part of a wider strategic purpose – for example, one that is aligned to one or more of the UN Sustainable Development Goals. Once determined, a deep green strategy can be embedded throughout an organization’s activities, operations, supply chain, policies, procedures, products and services, thus becoming part of, and supporting, the organization’s culture. There are many organizations with a genuine deep green approach to strategy; see, for example, the case studies of Ørsted and Triodos in Chapter 1. Outdoor clothing manufacturer Patagonia is perhaps one of the best-known brands with a genuine deep green approach.

QUICK QUESTION What other examples of organizations with genuine ‘deep green’ strategies can you think of?

Building a sustainable finance system

Products and services can – and in a genuine deep green strategy will – be designed to deliver both financial and environmental and/or sustainability returns. As with organizations themselves, products and services can be ‘light’ or ‘deep’ green. Understanding how to develop, assess and evaluate the ‘green credentials’ of products and services and working with suitably qualified experts able to verify environmental and other sustainability impacts is a core part of many green and sustainable finance professionals’ work. In Chapters 6 to 11 we will look at the growing range of products and services developed by the finance sector to support sustainable banking, investment and insurance activities. As we will see in Chapter 12, to maintain confidence in the integrity of green and sustainable finance, green and sustainable finance professionals should take active steps to ensure that their professional activities and, as far as possible, those of their colleagues and organizations as a whole, are aligned with and support the transition to a low-carbon, sustainable world – that is, they should adopt a ‘deep green’ approach themselves. This involves, at a minimum, ensuring that products, services and advice offered are consistent with promoting this transition, and that financial activities that may harm the environment or society are identified and disclosed, if not avoided. Green and sustainable finance professionals have a particular responsibility to avoid deliberate or inadvertent greenwashing, and should take active steps to ensure their advice and activities do not in any way damage the integrity of the green and sustainable finance profession.

The importance of organizational culture in embedding sustainability To embed a ‘deep green’ strategy, and to achieve the COP26 Private Finance strategy objective of ensuring that ‘every professional financial decision takes climate change into account’, organizations need to develop and embed strong cultures that support these objectives. As individuals generally find it very difficult, if not impossible, to constantly refer to complex and often lengthy corporate strategy documents supported by policies, procedures and targets, it is culture that shapes the delivery of strategy – i.e. the decisions that employees make and the behaviours they demonstrate on a day-to-day basis. As we have seen in financial services in recent years, when organizational cultures do not support an ethos of customer-focused, ethical professionalism, this results in detrimental outcomes for customers, communities and usually (over the longer term) for the organization itself. On a more positive note, successful ‘deep green’ strategies supported by strong, purposeful organizational cultures can lead to positive, sustainable outcomes for customers, the organization and society. When an organization adopts and successfully communicates a compelling vision for green and sustainable finance, supported by well-defined principles and policies, investors, customers and

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especially employees (and potential employees) can become enthused and motivated by the alignment of corporate purpose with their individual values and beliefs. It is beyond the scope of this book and course to explore different approaches to and definitions of culture within financial services, or more broadly. For our purposes, we follow the UK Financial Conduct Authority’s (FCA) definition of culture as ‘the habitual behaviours and mindsets that characterize an organization’.70 Whilst culture, then, is a collective term for the overall ethos of an organization, this emphasizes the importance of the social and professional norms inculcated by organizations, which influence and shape the actions and decisions taken by individuals. The FCA suggests there are four key drivers of culture: ●●

governance

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leadership (the importance of ‘tone from the top’)

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reward and management of people

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purpose

There is a fifth important driver to consider, too. If all finance professionals, at all levels, are expected to include climate change (and, we would argue, broader sustainability factors as well) in their decisions and activities, then they must develop an appropriate level of knowledge of climate risk and green and sustainable finance relevant to their role, function and organization. Education and training for all finance professionals – not just sustainability professionals – is a key driver of culture and helps develop and sustain the individual values and collective norms required to fully embed the principles and practice of green and sustainable finance throughout financial institutions, and the financial services sector overall.

Governance and leadership Senior leaders – non-executives and executive directors – are acknowledged as one of the most powerful influences on organizational culture, with the importance of ‘tone from the top’ underlined by many academic, regulatory and other studies and investigations in financial services, and business more broadly. In particular, the roles of chairs and chief executives are pivotal in shaping an institution’s culture. The ‘tone from the top’ has an immediate and tangible impact on norms and behaviours, both through senior leaders’ communication (what they say) and role modelling (what they do). Given the importance of demonstrating ‘tone from the top’ in developing and sustaining strong, purposeful cultures within institutions, chairs, chief executives and board members should take the lead in including environmental and social sustainability into strategies, plans, decision making, and both internal and external

Building a sustainable finance system

corporate messaging. At present, however, and perhaps not surprisingly given that it has emerged as a key focus for many organizations only in recent years, most boards and board members lack expertise in climate change and broader environmental and social sustainability areas. A 2021 study by the NYU Stern Center for Sustainable Business, for example, found that of the 1,188 individuals who were board members of US Fortune 100 companies, only 20 had relevant credentials relating to sustainable business and sustainable development, 14 had relevant credentials relating to conservation and four had relevant credentials relating to ESG investing.71 A detailed examination of the benefits of diversity in the boardroom, senior leadership, and indeed at all levels of an organization, is beyond the scope of this book. There is increasing evidence that ethnic, gender and other forms of diversity – including diversity of thought – support improved corporate performance and investment returns, especially over the longer term. From a sustainability perspective, increased diversity directly supports UN SDG 5 (gender equality) and SDG 10 (reduced inequalities). There is also emerging evidence that gender diversity, at least, may help align organizations with the goals of the Paris Agreement, too. In a study of the world’s largest 1,000 companies conducted by Arabesque, a sustainable investment and advisory firm, those with more women on their board were found to be more aligned with limiting global warming to 1.5°C above pre-industrial levels.72 Correlation and causation can be confused, however, and there is no definite evidence for a greater proportion of female board members leading to reductions in emissions; it may be that female non-executives are drawn to companies that are already committed to strategies aligned with the goals of the Paris Agreement and other sustainability objectives.

QUICK QUESTION What do you think? Are more diverse organizations more likely to be aligned with sustainability goals?

Reward and incentives Remuneration and incentive plans have proven to be an effective tool to focus management’s efforts on key priorities and drive desired outcomes. As organizations, including financial institutions, seek to transition to net zero, linking reward to climate and broader environmental and sustainability targets will help embed these within firms’ strategies and cultures. According to a Climate Disclosure Project (CDP)

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report, half of Europe’s largest firms now link executive pay to climate change. In 2019, according to the CDP, 47 per cent linked senior management remuneration to climate goals.73 A number of major financial institutions also link, or are planning to link, executive remuneration to environmental, social and governance (ESG) criteria. For instance, Deutsche Bank announced that, from 2021, executive remuneration will be linked to its sustainable finance investments, on the sustainability ratings it receives from five leading ESG ratings agencies, and on success achieved in reducing the bank’s own energy consumption. BNP Paribas links approximately 20 per cent of executives’ variable pay to meeting ESG criteria, and BBVA links all employees’ remuneration to the bank’s sustainability targets. Speaking at a UNEP FI roundtable in October 2020, former Bank of England governor Mark Carney said banks should link executive pay to climate targets as part of the effort to align the finance sector with the objectives of the Paris Agreement. It is important to note that, because most climate and broader sustainability targets tend to have longer-term horizons, typical annual and three-year incentives are not easy to align with longer-term climate change goals. Nonetheless, even short-term incentives can have a significant impact in terms of organizational culture. To encourage the longer-term decision making often associated with the large, long-term capital investments required in green and sustainable finance, firms should consider introducing separate long-term incentive plans focused solely on climate, environmental and sustainability goals.

Education and training If ‘deep green’ organizational cultures and strategies are to be successfully embedded, and if every professional financial decision is to take climate change (and broader environmental and sustainability factors) into account, then every financial professional needs to have an appropriate level of knowledge of green and sustainable finance to make such decisions in an informed manner. At present, many financial institutions rely on separate sustainability teams to shape firms’ strategies, operations and activities. Such teams seek to influence, formulate, drive, support, monitor and improve the organization’s green and sustainable goals, often engaging with many of the organizations and initiatives introduced in this chapter. Sustainability teams play an important role as change agents, but in the longer term sustainability needs to become part of every professional’s role and skillset. To embed sustainability in decision making – and culture – throughout institutions, and throughout the financial services sector as a whole, all finance professionals must

Building a sustainable finance system

develop an appropriate level of knowledge (and be able to apply this) relevant to their role, function and organization. As a minimum, therefore, all finance p ­ rofessionals should develop and demonstrate their knowledge in the following areas: ●●

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the basic science of climate change and global warming (and, increasingly, wider environmental issues such as biodiversity); the impacts of climate change on the environment, economy, society and the financial services sector; the cross-cutting nature and importance of climate, environmental and social sustainability risks (physical, transition and liability risks);

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the impacts and opportunities of the transition to a sustainable, low-carbon world;

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financial products and services that support the transition to net zero;

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how individuals can identify and take active steps to prevent inadvertent or deliberate greenwashing.

As well as supporting firms’ cultures, developing the capability and competence of colleagues in these areas supports firms’ business strategies and operations, helping them identify and take advantage of the opportunities from the transition to a sustainable, low-carbon world and provide appropriate advice to their customers and clients. It also supports individuals’ personal and professional development. Furthermore, given the importance many individuals attach to sustainability issues, providing relevant education and training and helping individuals throughout organizations understand how they are contributing to a successful transition to net zero helps align personal and corporate values and creates a strong sense of shared purpose. This is particularly relevant in terms of younger generations; Millennials, Generation Y and Generation Z all express strong preferences about working for organizations that share their values and have a strong sense of social purpose. By demonstrating how financial services play a leading role in the transition to a sustainable, lowcarbon world, as set out in Article 2.1 (c) of the Paris Agreement, the financial services sector can make a strong case to potential new recruits that, if they want to save the world, they should join a bank, insurer or investment fund. Professional bodies, such as the Chartered Banker Institute, play an important role in green and sustainable finance education and training by defining the professional standards and educational requirements at the global, regional and national levels relevant to different groups and levels of finance professionals. This includes: ●●

developing professional qualifications that certify individuals as having achieved national/regional/global competency benchmarks;

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accrediting firms’ internal training against recognized professional standards; supporting the continuing professional development (CPD) of individuals throughout their careers; and through individuals’ ongoing commitments to professional codes of conduct, promoting higher standards of professional behaviour.

Unlike internal training provided by firms, recognized professional qualifications provide tangible, transferable external recognition of knowledge and skills gained. This is valued by individuals in terms of personal and professional development, and by global and regional financial institutions where consistent benchmarks of competence facilitate cross-border, collaborative working. In addition, regulators value professional qualifications as a means to benchmark training and competence across firms, and to certify that individuals, particularly those in senior or key positions, have an appropriate level of competence for their role. Recognizing the important role of professional bodies in supporting the development of climate, green and sustainable finance, in 2020 the UK Government led the development of the Green Finance Education Charter, as the reading below sets out.

READING Green Finance Education Charter74 In June 2019, the UK Government published its Green Finance Strategy. This included a commitment to develop a Green Finance Education Charter designed to help build the capacity and capability of the green and sustainable finance sector in the UK and internationally. A year later, in June 2020, 12 leading UK-based professional bodies, including the Chartered Banker Institute, launched the Charter. The professional bodies involved represent more than a million accountants, actuaries, bankers, financial analysts, treasurers, risk managers and other professionals who are fundamental to the definition, integration and deployment of professional and technical standards across the financial system. They play a key role in ensuring, in Mark Carney’s words, that ‘every professional financial decision takes climate change into account’. The Charter is a collective commitment to developing the green and sustainable finance knowledge and skills of the banking, finance and professional services sectors to mainstream green and sustainable finance. Signatories have all pledged to incorporate green and sustainable finance principles and practice into their Codes

Building a sustainable finance system

of Conduct and into education and training programmes for professionals worldwide, and to undertake other activities, including; ●●

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engaging with members, clients, customers and the general public to raise awareness of climate change and environmental issues, and the role of the finance professions in tackling these; developing new green and sustainable finance education resources for finance professionals, including new global benchmark qualifications such as the Certificate in Green and Sustainable Finance (Chartered Banker Institute) and the Certificate in ESG Investing (CFA Institute); encouraging the adoption of relevant global and national standards, frameworks, policy and guidance that support the mainstreaming of green and sustainable finance; and launching an open-source Green Finance Education Toolkit to provide resources for educators, regulators and others internationally who are seeking to develop capacity and capability, especially in the developing world.

Within the first 18 months of the Charter, nearly 110,000 finance professionals had developed their green and sustainable finance knowledge and skills through qualifications, CPD and events delivered by Charter signatories.

QUICK QUESTION How could you use your learning from this course to help embed a ‘deep green’ approach within your own professional practice, team and organization?

Key concepts In this chapter, we introduced: ●● ●●

●●

the key actors involved in building a sustainable financial system; the key policy and regulatory frameworks supporting green and sustainable finance; how intergovernmental bodies, governments and other organizations support the development of green and sustainable finance;

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some key industry initiatives on green and sustainable finance;

●●

ways in which sustainability may be embedded in organizational strategies.

Now go back through this chapter and make sure you fully understand each point.

Review The UN Framework Convention on Climate Change (UNFCCC) is the main international treaty to combat climate change. Prior to the Paris Agreement coming into effect in 2020, the 1997 Kyoto Protocol was the main global framework for cutting greenhouse gas emissions, but this has had limited impact as some major emitters and developing countries did not ratify or were not included. At COP21 in 2015, 197 countries concluded the Paris Agreement – the first, universal, legally binding global climate agreement providing a pathway to limit global temperature rises to below 2°C. The recognition of the key role of finance in tackling climate change, as set out in Article 2.1 (c) of the Paris Agreement, is a major influence on the growth of green and sustainable finance. Central banks and financial regulators play important roles in promoting green and sustainable finance at the global level, but could do more. In banking, Basel III requires banks to assess the impact of specific environmental risks but does not explicitly address the wider financial stability risks associated with systemic environmental risks. The Network for Greening the Financial System helps coordinate the work of central banks and regulators to address climate and environmental risks, and to support the development of green and sustainable finance. A wide range of alliances, initiatives and groups have been established to align the activities of the finance sector with the objectives of the Paris Agreement, the UN Sustainable Development Goals, and broader sustainability objectives. Many of these are partnerships between intergovernmental agencies such as the United Nations Environment Programme (UNEP) and finance sector institutions and associations. The key partnership in this area is the UNEP Finance Initiative (UNEP FI), which has developed the Principles for Responsible Investment (PRI), Responsible Banking (PRB) and Sustainable Insurance (PSI), amongst many other initiatives. The Glasgow Financial Alliance for Net Zero (GFANZ) was launched in April 2021 to coordinate the activities of existing alliances and initiatives. GFANZ members, including the Net Zero Banking Alliance, Net Zero Asset Owner Alliance and Net Zero Asset Manager Initiative, commit to aligning lending and investment portfolios with net zero emissions by 2050, setting 2030 interim targets, using science-based guidelines to do so.

Building a sustainable finance system

Green and sustainable principles and practice may be embedded in organizational strategies to guide short-, medium- and long-term planning to develop a growing range of green and sustainable products and services and, ultimately, to align organizations with global environmental and other sustainability goals. ‘Light green’ strategies are those in which green and sustainability factors are not central to an organization’s strategy; ‘deep green’ strategies have green and sustainable vision and purpose at their core. Strategies designed to give a misleading impression of an organization’s commitment to sustainability may amount to ‘greenwashing’. If greenwashing is not identified and prevented, it can become a real risk to the long-term viability of the transition to a sustainable, low-carbon world – including the continued growth of green and sustainable finance. Green and sustainable finance professionals have an important role to play in ensuring that greenwashing – whether intentional or inadvertent – is identified and avoided. To support the development of ‘deep green’ strategies and ensure that they are embedded throughout an organization’s activities and operations, developing and maintaining an appropriate organizational culture is key. Leadership and governance (‘tone from the top’), remuneration and incentives, and education and training all help develop and sustain strong cultures aligned with green and sustainable finance principles and practice. Table 3.2  Key terms Term

Definition

Basel III

The current framework for international banking regulation, developed by the Basel Committee on Banking Supervision.

Carbon neutral

A synonym for ‘net zero carbon emissions’ (i.e. focuses on carbon dioxide emissions only).

Climate neutral

A synonym for ‘net zero’ (i.e. includes carbon dioxide and other greenhouse gases).

Conference of the Parties (COP)

The governing body of the UNFCCC, which meets annually to review the implementation of the Convention and agreed climate change instruments, and provides a forum for the negotiation of new climate change agreements and policies.

‘Dark green’ strategies

Strategies in which green and sustainable principles and practices are fully embedded and direct the strategy and operations of an organization. (continued)

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Table 3.2  (Continued) Term

Definition

FSB

Financial Stability Board.

Glasgow Financial Alliance for Net Zero (GFANZ)

Co-ordinates the activities of more than 160 financial institutions from net zero initiatives including the Net Zero Banking Alliance, Net Zero Asset Owner Alliance and Net Zero Asset Manager Initiative, to accelerate the transition to net zero emissions by 2050 at the latest.

Kyoto Protocol

Prior to the Paris Agreement coming into effect in 2020, the 1997 Kyoto Protocol was the main global framework for cutting greenhouse gas emissions. In its first phase (2008–12) the Protocol covered only some 12% of global emissions, as some major emitters (e.g. the US) and developing countries did not ratify or were not included in the Agreement.

‘Light green’ strategies Strategies in which green and sustainability factors are not central to an organization’s strategy and operations. Nationally determined contributions (NDCs)

Countries’ plans to achieve their climate goals in line with the objectives of the Paris Agreement.

Negative emissions

Removing carbon dioxide or other greenhouse gases from the atmosphere. Techniques have not yet been developed successfully at the scale required to make a substantial contribution towards net zero targets.

Net zero

Balancing carbon dioxide and other greenhouse gas emissions from production and other activities released into the atmosphere with equivalent amounts captured and stored, and/ or offset (for example, through buying carbon credits).

Net zero carbon emissions

Balancing carbon dioxide emissions from production and other activities released into the atmosphere with equivalent amounts captured and stored, and/or offset (i.e. focuses on carbon dioxide only, not other greenhouse gases).

NGFS

Network for Greening the Financial System, established in 2017. The NGFS coordinates the work of central banks and financial regulators in response to climate change and broader environmental and sustainability risks.

OECD

Organization for Economic Co-operation and Development

Solvency II

The EU framework for insurance regulation.

TCFD

Task Force on Climate-related Financial Disclosures, set up by the FSB to develop recommendations on the disclosure of climate risks.

TFCR

Task Force on Climate-related Financial Risks, established by the Bank for International Settlements in 2020. (continued)

Building a sustainable finance system

Table 3.2  (Continued) Term

Definition

UNEP FI

A partnership between the UN Environment Programme and the global financial sector to promote sustainable finance.

UNFCCC

United Nations Framework Convention on Climate Change. Agreed in 1992 and ratified by 197 parties to the Convention, the UNFCCC is the key international treaty providing a global framework for combatting climate change.

Zero carbon

No carbon is emitted through production or other activities, therefore – in contrast with ‘net zero’ – no carbon needs to be captured or offset.

Notes 1 UNFCCC Standing Committee on Finance (2021) Summary by the Standing Committee on Finance of the fourth (2020) Biennial Assessment and Overview of Climate Finance Flows, https://unfccc.int/sites/default/files/resource/54307_1%20-%20UNFCCC%20BA%20 2020%20-%20Summary%20-%20WEB.pdf (archived at https://perma.cc/PRV6-TLXH) 2 UNFCC (August 2021) Race to Resilience: Catalysing a step-change in global ambition to build the resilience of 4 billion people by 2030, https://unfccc.int/climate-action/race-tozero-campaign (archived at https://perma.cc/E3X7-4AMM) and https://racetozero.unfccc. int/race-to-resilience/ (archived at https://perma.cc/H2RA-P8PV) 3 UN Climate Change (2022) NDC Registry, https://www4.unfccc.int/sites/ndcstaging/ Pages/Home.aspx (archived at https://perma.cc/JVG6-7DPL) 4 Climate Action Tracker (2019) Home: Climate Action Tracker, https://climateactiontracker. org (archived at https://perma.cc/6TDH-GK96) 5 Varro, L and Fengguan, A (2020) China’s net-zero ambitions: the next Five-Year Plan will be critical for an accelerated energy transition, IEA, https://www.iea.org/commentaries/ china-s-net-zero-ambitions-the-next-five-year-plan-will-be-critical-for-an-acceleratedenergy-transition (archived at https://perma.cc/4BLT-PXMP); Finamore, B (2020) What China’s plan for net-zero emissions by 2060 means for the climate, Guardian, https:// www.theguardian.com/commentisfree/2020/oct/05/china-plan-net-zero-emissions2060-clean-technology (archived at https://perma.cc/9P2Z-QCQH) 6 UN (2015) Paris Agreement, https://unfccc.int/sites/default/files/english_paris_agreement. pdf (archived at https://perma.cc/CUY5-K3H7) 7 UN: Climate Change (2022) Global Stocktake, https://unfccc.int/topics/global-stocktake (archived at https://perma.cc/L36V-2UXU) 8 IPCC (2018) Special Report: Global Warming of 1.5°C, https://www.ipcc.ch/sr15/ (archived at https://perma.cc/AA4S-HXBZ) 9 IPCC (2021) Climate Change 2021: The Physical Science Basis, https://www.ipcc.ch/ report/ar6/wg1/ (archived at https://perma.cc/QXZ9-H3KS)

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Building a sustainable finance system 25 European Commission (2018) Renewed Sustainable Finance Strategy and implementation of the Action Plan on Financing Sustainable Growth, https://ec.europa.eu/info/ publications/sustainable-finance-renewed-strategy_en (archived at https://perma.cc/ ENA4-JFYV) 26 European Commission (2019) European Green Bond Standard, https://ec.europa.eu/info/ business-economy-euro/banking-and-finance/sustainable-finance/european-green-bondstandard_en (archived at https://perma.cc/C2F8-J7P8) 27 European Commission (nd) Retail Financial Products, https://susproc.jrc.ec.europa.eu/ product-bureau/product-groups/432/home (archived at https://perma.cc/ZR34-XCP6) 28 European Commission (nd) Regulation on Sustainability-related Disclosure in the Financial Services Sector, https://ec.europa.eu/info/business-economy-euro/banking-andfinance/sustainable-finance/sustainability-related-disclosure-financial-services-sector_en (archived at https://perma.cc/LNU5-LQB4) 29 European Commission (2020) Sustainable finance – obligation for investment firms to advise clients on social and environment aspects of financial products, https://ec.europa. eu/info/law/better-regulation/have-your-say/initiatives/12068-Sustainable-finance-­ obligation-for-investment-firms-to-advise-clients-on-social-and-environmental-aspects-offinancial-products_en (archived at https://perma.cc/EV5Z-D6GZ) 30 European Commission (2014) Corporate Sustainability Reporting, https://ec.europa. eu/info/business-economy-euro/company-reporting-and-auditing/company-reporting/­ corporate-sustainability-reporting_en (archived at https://perma.cc/2PHU-UMUZ) 31 European Commission (2021) A European Green Deal, https://ec.europa.eu/info/ strategy/priorities-2019-2024/european-green-deal_en (archived at https://perma.cc/ FB3D-BLG4) 32 European Commission (2020) Finance and The Green Deal, https://ec.europa.eu/info/ strategy/priorities-2019-2024/european-green-deal/finance-and-green-deal_en (archived at https://perma.cc/TH5K-8273) 33 European Commission (2020) Sustainable Finance Taxonomy – Regulation (EU) 2020/852, https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32020R0852 (archived at https://perma.cc/B35F-T3V8) 34 European Commission (2020) Taxonomy Report: Technical Annex, https://finance. ec.europa.eu/system/files/2020-03/200309-sustainable-finance-teg-final-reporttaxonomy-annexes_en.pdf (archived at https://perma.cc/AL4P-XAGE) 35 Reclaim Finance (2022) Open letter from 92 CSOs: To avoid taxonomy-enabled greenwashing, financial institutions must exclude fossil gas and nuclear energy from all their products and bonds marketed as sustainable or green, https://reclaimfinance.org/ site/wp-content/uploads/2022/03/Open-letter-from-92-CSOs-No-gas-and-nuclear-insustainable-products.pdf (archived at https://perma.cc/Z2G9-JQPQ) 36 European Central Bank (2020) Guide on Climate-related and Environmental Risks: Supervisory expectations relating to risk management and disclosure, https://www. bankingsupervision.europa.eu/ecb/pub/pdf/ssm.202011finalguideonclimate-relateda​ ndenvironmentalrisks~58213f6564.en.pdf?1f98c498cb869019ab89194a118b9db4 (archived at https://perma.cc/G2W8-9RPL)

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Green and Sustainable Finance 37 ECB (2022) Supervisory assessment of institutions’ climate-related and environmental risks disclosures: ECB report on banks’ progress towards transparent disclosure of their climate-related and environmental risk profiles, https://www.bankingsupervision. europa.eu/ecb/pub/pdf/ssm.ECB_Report_on_climate_and_environmental_ disclosures_202203~4ae33f2a70.en.pdf (archived at https://perma.cc/ULU6-JLR3) 38 EBA (2019) EBA Action Plan on Sustainable Finance, https://www.eba.europa.eu/sites/ default/documents/files/document_library/EBApercent20​ctionpercent20planpercent20​ onpercent20sustainablepercent20finance.pdf (archived at https://perma.cc/W3V2-GNDQ 39 EBA (2021) EBA publishes its Report on management and supervision of ESG risks for credit institution and investment firms, https://www.eba.europa.eu/eba-publishesits-report-management-and-supervision-esg-risks-credit-institutions-and-investment (archived at https://perma.cc/J58V-YXJF) 40 ESMA (2020) Strategy on Sustainable Finance, https://www.esma.europa.eu/sites/default/ files/library/esma22-105-1052_sustainable_finance_strategy.pdf (archived at https:// perma.cc/6TGH-PPK6) 41 European Commission (2022) Regulation on Sustainability-related Disclosure in the Financial Services Sector, https://ec.europa.eu/info/business-economy-euro/banking-andfinance/sustainable-finance/sustainability-related-disclosure-financial-services-sector_en (archived at https://perma.cc/LNU5-LQB4) 42 EIOPA (nd) Sustainable Finance Activities 2022–2024, https://www.eiopa.europa.eu/sites/ default/files/publications/other_documents/eiopa-sustainable-finance-activities-2022-2024. pdf (archived at https://perma.cc/DX2S-M82A) 43 EIOPA (2020) Sensitivity Analysis of Climate-Change Related Transition Risks: EIOPA’s First Assessment, https://www.eiopa.europa.eu/media/news/sensitivity-analysis-ofclimate-change-related-transition-risks-eiopa%E2%80%99s-first-assessment_en (archived at https://perma.cc/889M-3YVE) 44 EIOPA (2022) Climate Stress Test for The Occupational Pensions Sector 2022, https:// www.eiopa.europa.eu/climate-stress-test-occupational-pensions-sector-2022_en (archived at https://perma.cc/9EHC-J24J) 45 BCB (nd) Sustainability, https://www.bcb.gov.br/en/financialstability/sustainability (archived at https://perma.cc/YXZ5-9ZZR) 46 CEBDS (nd) Home, https://cebds.org (archived at https://perma.cc/4R8P-ZYB2) 47 LAB (nd) Home, http://labinovacaofinanceira.com (archived at https://perma.cc/​ 328X-DRPW) 48 Caswell, G (2022) PBoC warns of defaults following climate stress test, Green Central Banking, https://greencentralbanking.com/2022/02/21/china-defaults-climate-stress-testpboc/ (archived at https://perma.cc/L369-GBMX) 49 The Federal Government of Germany (2021) German Sustainable Finance Strategy, https://www.bundesfinanzministerium.de/Content/EN/Standardartikel/Press_Room/ Publications/Brochures/sustainable-finance-strategy.pdf?__blob=publicationFile&v=8 (archived at https://perma.cc/TZY3-VPC4) 50 Monetary Authority of Singapore (2020) Green Finance Action Plan, https://www.mas. gov.sg/-/media/MAS/News/Media-Releases/2020/MAS-Green-Finance-Action-Plan.pdf (archived at https://perma.cc/7M55-JKL9)

Building a sustainable finance system 51 IBF (nd) Sustainable Finance Technical Skills and Competencies, https://www.ibf.org.sg/ programmes/Pages/SF_TSC.aspx (archived at https://perma.cc/E58B-VYBH) 52 South Africa Sustainable Finance Initiative (2021) Overview: National Treasury publishes updated technical paper on financing a sustainable economy, https://­ sustainablefinanceinitiative.org.za (archived at https://perma.cc/T9DY-KKS2) 53 Republic of South Africa (2020) Financing a Sustainable Economy, https://­sustainablefinanceinitiative.org.za/wp-content/downloads/Sustainability_­ technical_paper_2020.pdf (archived at https://perma.cc/6P6N-D9DV) 54 Republic of South Africa (2022) South African Green Finance Taxonomy, www.treasury. gov.za/comm_media/press/2022/SA%20Green%20Finance%20Taxonomy%20-%20 1st%20Edition.pdf (archived at https://perma.cc/EY7E-P79E) 55 SEC (2022) SEC proposes rules to enhance and standardize climate-related disclosures for investors, Press Release, https://www.sec.gov/news/press-release/2022-46 (archived at https://perma.cc/F8XV-YRKB) 56 Japan Ministry of the Environment (2018) Toward Becoming a Big Power in ESG Finance, https://www.env.go.jp/policy/01_Recommendation(full)pdf (archived at https:// perma.cc/8FP5-TU8A) 57 Financial Service Agency (2020) Establishment of ‘The Expert Panel on Sustainable Finance’, https://www.fsa.go.jp/en/news/2020/20201225-2/20201225-2.html (archived at https://perma.cc/FT3C-MAHU) 58 Green Board Principles (2021) Green Bond Principles: Voluntary Process Guidelines for Issuing Green Bonds, Paris, https://www.icmagroup.org/assets/­documents/Sustainablefinance/2021-updates/Green-Bond-Principles-June-2021-100621.pdf (archived at https:// perma.cc/DEP7-ULWK) 59 ICMA (2021–22) The Principles, Guidelines and Hand Books, https://www.icmagroup. org/sustainable-finance/the-principles-guidelines-and-handbooks/ (archived at https:// perma.cc/J33E-MQ59) 60 LSTA (2021) Green Loan Principles, https://www.lsta.org/content/green-loan-principles/ (archived at https://perma.cc/VN77-HEQA) 61 LSTA (2021) Social Loan Principles, https://www.lsta.org/content/social-loan-principlesslp/ (archived at https://perma.cc/4XUT-D69D) 62 LSTA (2021) Sustainability Linked Loans, https://www.lsta.org/content/sustainabilitylinked-loan-principles-sllp/ (archived at https://perma.cc/9MYL-GMV5) 63 SBFN (2021) Accelerating Sustainable Finance Together: Evidence of policy innovations and market actions across 43 emerging markets, https://sbfnetwork.org/wp-content/ uploads/pdfs/2021_Global_Progress_Report_Downloads/SBFN_D003_GLOBAL_ Progress_Report_02_Nov_2021.pdf (archived at https://perma.cc/YRH6-W8T7) 64 GABV (2021) Principles of Values-Based Banking, https://www.gabv.org/wp-content/ uploads/2022/02/Principles_def.pdf (archived at https://perma.cc/9ZGP-ZPC3) 65 Cambridge Institute for Sustainability Leadership (2022) Disclosure – The ClimateWise Principles, https://www.cisl.cam.ac.uk/business-action/sustainable-finance/climatewise/ principles (archived at https://perma.cc/J9NJ-QSDH)

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Green and Sustainable Finance 66 Carney, M (2021) Building a Private Finance System for Net Zero: Priorities for Private Finance for COP26, https://ukcop26.org/wp-content/uploads/2020/11/COP26-PrivateFinance-Hub-Strategy_Nov-2020v4.1.pdf (archived at https://perma.cc/96H4-AAS8) 67 Hotten, R (2015) Volkswagen: The scandal explained, BBC, https://www.bbc.co.uk/ news/business-34324772 (archived at https://perma.cc/Z4PV-NNPE) 68 Ethical Consumer (2020) What is greenwashing? https://www.ethicalconsumer.org/ transport-travel/what-greenwashing (archived at https://perma.cc/Q97Z-X7E2) 69 Truth in Advertising (2022) Companies accused of greenwashing, h ­ ttps://www.­ truthinadvertising.org/six-companies-accused-greenwashing/ (archived at https://perma. cc/B7F7-6BWF) 70 FCA (2020) Culture and Governance, https://www.fca.org.uk/firms/culture-and-­ governance (archived at https://perma.cc/9BF8-CKLH) 71 T Whelan (2021) U.S. corporate boards suffer from inadequate expertise in financially material ESG matters (NYU Stern), https://papers.ssrn.com/sol3/papers.cfm?abstract_ id=3758584 (archived at https://perma.cc/74WH-28NY) 72 Reuters (2022) Boardrooms with more women deliver on climate, says Arabesque, https:// www.reuters.com/business/sustainable-business/boardrooms-with-more-women-delivermore-climate-says-arabesque-2022-03-22/ (archived at https://perma.cc/3GVZ-B8JP) 73 CDP (2019) European Report: Higher Ambition, Higher Expectations, www.cdp.net/ en/articles/companies/half-of-europes-largest-firms-now-link-executive-pay-to-climatechange (archived at https://perma.cc/4DCN-ZT8Y) 74 Green Finance Institute (2020) Financing the green recovery with launch of world’s first green finance education charter, https://www.greenfinanceinstitute.co.uk/financing-thegreen-recovery-with-launch-of-worlds-first-green-finance-education-charter/ (archived at https://perma.cc/Z6T2-3QKJ)

4

Measuring and reporting impacts, alignment and flows of green and sustainable finance Introduction In this chapter, we examine how impacts and outcomes of green and sustainable financing activities and decisions can be measured, monitored and reported. We outline some of the frameworks and tools to help measure impacts and outcomes of lending and investment decisions, and to monitor the alignment of lending and investment portfolios with the objectives of the Paris Agreement and broader sustainable goals. We examine the importance of ensuring independent external review and transparent disclosure, and introduce the new International Sustainability Standards Board (ISSB), which plans to consolidate existing standard-setting initiatives and bring greater consistency and comparability to sustainability reporting. We also consider the importance of monitoring, measuring and reporting flows of public and private sector investment to support climate change mitigation and adaptation activities. This is crucial to track progress towards the Paris Agreement’s objectives of making flows of finance consistent with the transition to a sustainable, low-carbon world. Finally, we consider advances in the gathering and analysis of environmental performance and asset-level data, and how these may support impact analysis and monitoring flows of finance.

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L E A R N I N G OB J ECTI VES On completion of this chapter, you will be able to: ●●

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Outline how environmental and sustainability performance and impacts can be measured and reported. Describe some of the frameworks and tools commonly used to measure and report impacts, and identify key organizations and approaches involved. Explain the importance of independent, external review. Describe approaches to monitoring the alignment of lending and investment portfolios with the objectives of the Paris Agreement, including PACTA and the SBTi. Explain the importance and challenges of monitoring, measuring and reporting flows of finance to track progress towards achieving Article 2.1 (c) of the Paris Agreement. Describe how advances in data availability and analysis can support impact analysis and monitoring flows of finance.

Monitoring, measuring and reporting: impacts and outcomes In the context of green and sustainable finance, monitoring, measuring and reporting can refer to: ●●

●●

●●

measuring and reporting the environmental and other impacts and outcomes of green and sustainable lending and investment decisions, and of other financial activities; monitoring the alignment of lending and investment portfolios, and financing activities overall, with the objectives of the Paris Agreement; and tracking and reporting flows of investment to green and sustainable assets, activities, and projects with the aim of meeting the objectives of Article 2.1 (c) of the Paris Agreement and other sustainable goals.

In this section, we examine the former – the ways in which the impacts and outcomes of green and sustainable lending and investment decisions, and of other financial activities, may be monitored, measured and reported. Developing, implementing and embedding consistent approaches to monitoring and reporting impact and outcomes at firm, project and/or asset level is key if green and sustainable finance is to become

Measuring and reporting impacts, alignment and flows

mainstream, and finance overall aligned with the objectives of the Paris Agreement (i.e. supporting climate change mitigation and adaptation) and the UN Sustainable Development Goals. Monitoring and reporting environmental and other impacts must become business as usual (BAU) for financial institutions and finance professionals, alongside established financial reporting mechanisms. This is the important concept of ‘double materiality’. Organizations should report the financial impacts of climate change and other environmental and sustainability factors on their operations and performance – and many already do. We briefly introduced the work of the Task Force on Climate-related Financial Disclosures (TCFD) in the previous chapter, and will explore this in more detail in Chapter 5. Organizations should also report, though, the positive and negative impacts of their activities and operations on the environment and society. We define double materiality, therefore, as: Identifying and reporting both (i) the financial impacts of climate change and other environmental and social sustainability factors on an organization, and (ii) the environmental and social impacts of the organization’s activities and operations on nature and society.

In terms of financial institutions, the latter includes both direct impacts (e.g. greenhouse gas emissions released by offices and data centres) and indirect impacts (from activities financed by lending, investment and other financial operations). As we will see in this chapter, measuring, monitoring and reporting these indirect impacts – referred to as ‘financed emissions’ in terms of those relating to greenhouse gases – is critical so that progress towards the objectives of the Paris Agreement and other sustainable goals can be tracked at the organization, sector, country and, ultimately, global levels.

QUICK QUESTION In what ways (if any) are green and sustainable investments and activities monitored and reported in your organization, or in an organization with which you are familiar?

What are we measuring? Monitoring systems may seek to measure processes intended to lead to positive green and sustainable outcomes, and/or try to directly measure the impacts and outcomes themselves. To try to ensure the delivery of positive environmental and social outcomes and to avoid greenwashing, the monitoring and measuring of impacts and outcomes,

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including review by suitably qualified, independent third parties, is essential, as we will see below.

Processes Process monitoring describes the assessment and evaluation, often by independent third parties, of an organization’s principles, policies, procedures and practices. In the context of green and sustainable finance, these would be those intended to shape an organization’s decision making to lead to positive environmental and/or social outcomes from lending, investment or other financial activities. It is worth looking at the implementation of the Equator Principles (introduced briefly in Chapter 3) to illustrate and understand the advantages and disadvantages of process monitoring. The Equator Principles1 are a risk management framework which financial institutions, especially banks involved in project finance (large-scale lending for infrastructure and similar projects) have adopted for assessing and managing environmental and social risks in projects. They provide a scale against which financial institutions’ policies, procedures and practices can be aligned and benchmarked. In 2016, UNEP found that the impact of the Equator Principles had been mixed. Supporters argue that these are visionary principles that have helped to redefine and enhance environmental and social practices by promoting convergence around common environmental and social standards. Critics argue that, being processoriented, the Principles do not set criteria on desired environmental and sustainable outcomes, or give guidance on the conditions that would result if project finance were rejected because of environmental or social issues. There are also concerns regarding the validity of CO2 emissions calculations, and about the willingness of financial institutions to disclose data voluntarily. In addition, UNEP found that organizations’ main motivations for adopting and using the Equator Principles were centred on regulatory compliance, managing project risks, and seeking reputational benefits rather than on identifying and seeking to achieve positive environmental impacts.2 Adopting green and sustainable finance principles and practices, such as those included in the Equator Principles, is desirable in the sense that it may reflect a changing culture and approach within an organization. By themselves, however, they do not ensure that positive environmental and social impacts are achieved. Process monitoring can confirm that appropriate principles, policies and procedures are in place, and independent assurance and verification can be sought to validate this. However, this does not by itself necessarily lead to changes in lending and investment flows consistent with achieving the objectives of the Paris Agreement and broader sustainability goals.

Impacts and outcomes: assess, monitor and report For these reasons, we need to assess, measure and report the impacts and outcomes of financing decisions, especially greenhouse gas emissions (or the reduction in these)

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alongside the principles, policies and procedures that guide decision making. In the context of green and sustainable finance, this means identifying the desired environmental and sustainable outcomes before making an investment or lending decision, and then monitoring and measuring these during the lifespan of the loan or investment, and perhaps beyond. For financial institutions, this implies supplementing traditional accounting measures of financial performance with measures and reporting of non-financial performance, including a wide variety of environmental impacts relating to climate change mitigation and adaptation, such as reducing greenhouse gas emissions, supporting reforestation or improving biodiversity. A key challenge for financial institutions and others in measuring impacts and outcomes is the availability and quality of relevant environmental and other performance data, especially relating to greenhouse gas emissions, without which consistent and comparable reporting is impossible. In turn, this means that institutions cannot fully understand their – and others’ – exposure to climate-related and other environmental risks, and the extent to which lending and investment decisions, and portfolios overall, are aligned with the Paris Agreement and other sustainable objectives. Impact analysis is also required by finance sector initiatives, including the UN Principles for Responsible Banking and Principles for Responsible Investment (both introduced in the previous chapter and examined in more detail in Chapters 6 and 9, respectively). The analysis and reporting of sustainability impacts and outcomes is a rapidly developing area, with many organizations and initiatives working to measure and report greenhouse gas emissions and broader categories of environmental and social sustainability impacts, and to provide insightful, actionable data to financial institutions on these. Remember from earlier chapters that it is relatively straightforward for financial institutions to measure and report their direct (Scope 1 and Scope 2) emissions, but much more complex to measure and report indirect, financed emissions (Scope 3) from their lending and investment activities, which account for the majority of financial institutions’ emissions and impacts. A little later in this chapter we introduce several approaches to measuring and reporting financed emissions, as well as broader sustainability impacts and outcomes. We also briefly introduce some of the approaches, standards and organizations Green and Sustainable Finance Professionals should be aware of. We highlight the work of the new International Sustainability Standards Board (ISSB), which is consolidating a number of existing sustainability reporting initiatives with the aim of enhancing the quality, consistency and comparability of sustainability disclosures to support better decision making by investors and others. First, though, we consider how Green and Sustainable Finance Professionals may approach the analysis, assessment and monitoring of impacts and outcomes, and the importance of external review in this. A helpful, commonly used methodology for monitoring the impact and outcomes of green and sustainable investments is

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the assess–monitor–report approach, described in the following reading. As can be seen, this approach requires a considerable amount of thought and work at the preinvestment stage to ensure that relevant impacts and outcomes are identified, and appropriate measurement tools and techniques selected.

READING Green Investment Group assess–monitor–report approach3 Assess How to assess the green impact and risks of projects prior to investment as part of the due diligence process. The process described will enable a project’s forecast green performance to be assessed against a defined set of investment criteria and the associated risks to be considered. Project assessment should be conducted in a manner appropriate to the geography, sector, risk and size of the proposed investment. Consideration should be given to the investment’s material alignment with any environmental, social and governance investment criteria, including specific low-carbon criteria within any policy or mandate requirement (the Green Investment Policy): ●●

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Establish a Green Investment Policy which makes policy requirements, investment criteria and/or stated objectives against which potential projects can be assessed for alignment publicly available. Assess the potential investment management team’s capability, capacity, and commitment to meet stated objectives in line with policy requirements. Request performance data from investee management, including the project’s forecast renewable electricity and/or heat generation or demand reduction, and project life. The forecast carbon savings associated with the project can then be considered. Appoint external environmental and social experts, where appropriate, to support due diligence. Consider green risks – that the project may not deliver the forecast green and other intended impacts. Material green risks identified during this process should be mitigated in an action plan and/or included in monitoring. Where the due diligence process identifies gaps or non-alignment with policy requirements, agree an action plan with investee management to close these. Integrate green covenants into financing/loan documentation; they should have legal status and recourse to enforcement measures equal to those of financial covenants. Consider due diligence, forecast green performance and green risk assessment as part of the investment decision-making process.

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Monitor How to monitor the green performance of projects, including issues initially identified through the due diligence process. Once investment has been provided to a project, the performance of the project is monitored. The process described here shows how to monitor the green impact and green risks, including compliance with agreed covenants and environmental and social project-related risks. In addition, investees should provide regular operational updates/reports that consistently address the progress made towards the expected green impact and other environmental and social measures. Specific requirements will depend on the characteristics and size of the investment, the geography and the sector: ●●

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Annual green reporting – the investee should complete an annual report detailing the forecast and/or actual performance of the project, including all relevant source data and references required for audit purposes. The report can, if required, be prepared or verified by a suitable, independent third party. The investee should also report material environmental and social incidents, accidents and harms to the investor as soon as possible (with associated details of any mitigation and/or actions taken to address the issue). The investor should consider these and, in consultation with investee management, assess if there is a requirement for remediation or mitigation action. Independent monitoring – as part of the covenants agreed, the investor should retain an independent environmental and social expert to conduct periodic monitoring and verification of green risks, action plans, forecast and actual green performance, and ongoing compliance with wider environmental and social covenants. Once the data from an investment has been collected and verified by an independent third party (if required), it can be aggregated for external reporting to stakeholders.

Report How to collect, validate and report data on the performance of portfolio investments for green and responsible investment-related data. It is critical that green impact is periodically reported to stakeholders on a transparent basis. Green impact should be reported using defined metrics such as tonnes of carbon dioxide equivalent (CO2e), tonnes of oil equivalent (toe), tonnes of other air pollutant emissions and renewable energy generated (GWh). Both forecast green impact performance (as assessed at financial close and revised periodically thereafter) and actual green impact performance delivered should be reported to the relevant

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stakeholders. Wider disclosure to the public can take the form of individual investment non-financial performance reporting, or aggregated reporting (e.g. by sector): ●●

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The calculation of a project’s green impact is produced by comparing relevant information and data derived from that project against relevant baseline (or counterfactual) data for the assumed environmental impacts that would occur if the project did not take place. The methodology used to calculate a project green performance should be publicly disclosed at the institutional level. This should include disclosure of sector-specific approaches, assumptions and parameters (e.g. greenhouse gas emission factors used for fuels and electricity, and the approaches to calculating jobs created as a result of the investment).

The Green Investment Group approach outlined in the reading is broadly similar to that recommended by many policymakers, regulators and industry groups and adopted by many financial institutions. It is codified in market standards and guidelines such as the Green Bond and Green Loan Principles, as well as the Climate Bonds Standard and the proposed EU Green Bond Standard (discussed in Chapters 6 and 7). All place significant emphasis on identifying intended green and sustainable impacts and outcomes pre-investment, then monitoring, measuring and reporting the actual impacts – both positive and negative – often with the assistance and/or assurance of suitably qualified, independent third parties.

QUICK QUESTION Why, in your view, is independent external review of impacts and outcomes so important?

External review As noted above, independent external review can be recommended or required to support the monitoring, measuring and reporting of environmental and other sustainability impacts at both the pre-investment and post-investment stages. In order to ensure that the intended impacts are achieved (or, if not, that this is disclosed) and that other positive or negative impacts of lending and investment decisions are reported, to avoid inadvertent or deliberate greenwashing and to maintain the integrity of the growing green and sustainable finance sector, independent third-party review of impacts and outcomes is key.

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Green and Sustainable Finance Professionals and their organizations will need to work with a range of independent consultants, reviewers and verifiers, either as part of their investment decision-making and monitoring processes (as investors), or as potential investees preparing green and sustainable projects for investment. It is important, therefore, for Green and Sustainable Finance Professionals to understand different approaches to external review and the advantages and disadvantages of each. The term ‘external review’ is generally used as a catch-all to cover similar terms such as audit, assurance, attestation, certification, validation, verification and secondor third-party review. Although there are differences between these, which we explore below, the intended outcomes are generally the same: ●●

to verify the environmental or broader sustainability impacts of investments with the aim of bringing certainty to investors;

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to avoid greenwashing;

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to maintaining confidence in the green and sustainable finance sector;

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to track alignment with the Paris Agreement and other sustainable goals and objectives.

External reviews may be conducted at different levels. For instance, this could be at the individual investment or project level, the investment programme level or the organizational level, encompassing an institution’s entire portfolio, although this is in its infancy given the scope and complexity involved. Importantly, external review occurs not only in respect of monitoring and measuring impact and outcomes once a lending or investment decision has been made. As we saw in the reading above, it is recommended that an expert, independent review of potential investments and projects is undertaken at an early stage of the investment decision-making process. This would usually seek to ensure that investments and intended project outcomes are: ●●

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supported by organizational strategy, policies and procedures aligned with green and sustainable finance principles and practices; likely to contribute to environmental objectives such as climate change mitigation or adaptation, as well as related areas such as improving biodiversity, reforestation and/or sustainability more broadly (depending on the investor’s desired outcomes); unlikely to harm other environmental and/or social objectives; aligned with recognized investment and project categories, such as renewable energy, biodiversity conservation and clean transportation (as set out, for example, in the Green Bond Principles, Climate Bonds Standard and the EU Taxonomy); and

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supported by a realistic assessment of material green risks, i.e. which may prevent the investment or project achieving the desired impacts.

There are various types and levels of external review:

Second-/third-party review and opinion In general, this refers to a review by a suitably qualified expert or institution (depending on the scope and size of the investment or project under consideration) of the areas set out in this section. A second-party review is when there is a degree of independence between the investment/project managers and the reviewer but where there may be a conflict of interest, or a perception of one. For example, this could be when the costs of the review are paid for by the organization seeking investment. A thirdparty review – for example, a review paid for by the potential investor rather than the investee – is fully independent, and therefore provides a greater level of confidence in the integrity of the review and its outcomes.

Verification Verification is when an investor obtains independent third-party assurance against designated criteria identified in advance. This often includes reference to market standards and guidance such as the Green Bond or Green Loan Principles, the Climate Bonds Standard and/or standards relating to environmental performance. Criteria may relate to the processes to be followed (for example, a verifier might report that an organization has benchmarked its internal policies and procedures to the Equator Principles), although, as we have explored above, in green and sustainable finance the verification of impacts and outcomes is of greater importance.

Certification Certification refers to a process by which investments are measured against recognized external standards and criteria, i.e. the criteria are not defined by the investor, as is the case with verification. Certification, therefore, provides a greater degree of independence and a higher level of assurance than verification. One of the bestknown certification schemes in green finance is the Climate Bonds Standard, which seeks to ensure that certified bonds meet a range of outcome-based sustainability criteria. This is to ensure that the investments and projects they support will achieve sustainable objectives consistent with the Paris Agreement and other environmental objectives. For a bond to be certified as a Climate Bond, prospective issuers must appoint an approved verifier (as illustrated in the following case study). The Climate Bonds Standard itself is considered in more detail in Chapter 7.

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Self-certification Self-certification, also known as a ‘first-party review’, refers to the self-review of investments and projects by the organization. Here there is clear scope for conflicts of interest to arise, or the perception of these. Some green and sustainable finance market standards and frameworks do allow self-certification (for example, the Green Loan Principles), but this tends not to be recommended. By definition, self-certification is not a form of external review, but we include it here for completeness.

CASE STUDY Becoming a Climate Bonds Standard Approved Verifier4 What is an Approved Verifier? Under the Climate Bonds Standard and Certification Scheme, an Approved Verifier will check a bond issuer’s upcoming bond against the organization’s Standard and sector-based technical criteria (for example, solar energy). If the bond complies with the Standard and Criteria, the Verifier will write a report to verify that the bond can be marketed to investors as a Climate Bonds Certified Bond and join the growing list of Certified Bonds. This is a rapidly growing market, and more companies around the world are joining to become an Approved Verifier in order to help certify the increasing number of green bonds. Training, support and oversight of Approved Verifiers are provided by the Climate Bonds Secretariat. Requirements to become an Approved Verifier To become an Approved Verifier, the company must demonstrate that they have competence and experience in the following three areas: ●●

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issuance of debt instruments in the capital markets and management of funds within issuing organizations; technical characteristics and performance of low-carbon projects and assets in the areas covered by the specific criteria available under the Climate Bonds Standard; provision of Assurance Services in line with the International Standards on Assurance Engagements ISAE 3000.

Verifiers are expected to use teams of professional staff and/or insured contractors who meet all these requirements for each engagement.

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In addition to the three criteria laid out above, the approval of Verifiers is also based on their geographic coverage and areas of technical competence: ●●

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geographic coverage of the approval is aligned with the coverage provided by the Verifier’s insurance policies for professional indemnity/professional liability; the technical scope of the approval is determined by the Verifier’s levels of experience and expertise in the different technical sectors covered by the Climate Bonds Standard.

Measuring and reporting greenhouse gas emissions and environmental performance We have discussed the importance of monitoring, measuring, externally reviewing and reporting climate change mitigation and adaptation impacts and outcomes. We have not yet considered, though, what actually needs to be measured in terms of greenhouse gas emissions and reductions and broader environmental and other sustainability outcomes. In many cases, this requires the monitoring, measurement and reporting of environmental metrics based on a scientific analysis of, for example, CO2 and other greenhouse gas emissions. Green and Sustainable Finance Professionals would be unlikely to be qualified to measure and report on these. This is a further reason why obtaining independent third-party review, verification and certification is so important. Investors, customers, regulators, policymakers and others need to have confidence in the environmental and sustainability data reported so that progress towards the objectives of the Paris Agreement and other sustainable goals can be accurately tracked, and accusations of greenwashing avoided.

QUICK QUESTION What indicators are you aware of relating to environmental performance or other areas of sustainability that are in use in your organization or in an organization with which you are familiar?

We introduced the concept of CO2e (carbon dioxide equivalent), the most commonly used measure of greenhouse gas emissions, in Chapter 2, and explored how other greenhouse gas emissions could be reported in CO2e by utilizing the global warming potential (GWP) of different gases. Annual CO2e is the most widely used metric for

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reporting greenhouse gas emissions, reductions in these and/or emissions avoided. Renewable energy generation and/or substitution of fossil fuel-powered energy generation, usually expressed in annual megawatt or gigawatt hours (MWh/GWh), are widely used, too. Other common metrics used in reporting environmental impacts in some key sectors are set out in Table 4.1. As with many other areas in green and sustainable finance, standardized approaches and methodologies for reporting environmental impacts are developing (and existing approaches are converging) due to demands from investors, financial institutions, regulators, policymakers and others for consistent, comparable data to help monitor and report impacts, and to track the alignment of financial institutions and finance overall with the objectives of the Paris Agreement and other sustainable goals.

Table 4.1  Common environmental reporting metrics Sector

Commonly used reporting metrics

Energy efficiency

• Annual energy savings, usually expressed in annual megawatt or gigawatt hours (MWh/(GWh) or equivalents • Reduction in greenhouse gas emissions, usually expressed in annual tonnes of CO2 equivalent (CO2e) • Greenhouse gas emissions avoided (annual CO2e)

Clean/ renewable energy

• Reduction in greenhouse gas emissions (annual CO2e) • Greenhouse gas emissions avoided (annual CO2e) • Renewable energy generation (annual MWh/GWh or equivalents) • Total capacity of renewable energy plants in megawatts or gigawatts (MW/GW)

Sustainable land use

• Capture of greenhouse gas emissions (estimated annual CO2e), for example, via reforestation • Surface area under conservation/reforestation (verified by appropriate certification scheme) • Impact on biodiversity (for example, number of species, distribution of species)

Water • Annual water savings/reductions in leakages conservation • Wastewater discharged per unit of product • Water quality indicators (for example, chemical pollutant content, fitness for human consumption) • Impact on biodiversity and aquaculture (for example, number of species, distribution of species, contaminant concentrations) (continued )

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Table 4.1  (Continued) Sector

Commonly used reporting metrics

Clean transport

• Reduction or avoidance of greenhouse gas emissions (annual CO2e and other gases emitted by vehicles, for example NO2) in comparison with existing transportation methods • Quantity of new clean transport infrastructure/assets provided (for example, number of electric vehicles, length and capacity of new railway lines) • Estimated reduction in non-clean transport use (i.e. substitution effect)

Three such approaches to the reporting of greenhouse gas emissions and other aspects of environmental performance are introduced below, including the newly established International Sustainability Standards Board (ISSB). Approaches and initiatives focusing on a broader range of sustainability impacts and outcomes are introduced later in this chapter. The ISSB is in the process of consolidating a number of existing standard-setting organizations and, in doing so, will bring greater consistency and comparability to disclosures.

Carbon Disclosure Project (CDP) The CDP is the most established environmental reporting NGO. It provides a widely respected and utilized global system of disclosures for companies, cities, and regional and national governments.5 Disclosures can be made in three areas – (a) climate change, (b) forests and (c) water security – through questionnaires completed by respondents and supported by detailed guidance and metrics to ensure consistency and comparability. Questionnaires are scored from A to D (with A being the highest rating for quality and transparency of disclosure). In 2020, approximately 10,000 companies (including nearly 300 financial institutions), more than 800 cities and over 130 regions and states disclosed their environmental impact through the CDP. The CDP does not require financial institutions to measure and report their Scope 3 (financed) emissions, however, so disclosures from financial institutions have tended to cover Scope 1 and 2 emissions only. Less than 20 per cent of the financial institutions disclosing their environmental impact through CDP report their financed emissions.6 In 2020, therefore, the CDP launched a project to help financial institutions measure and disclose Scope 3 emissions, including guidance to support this in questionnaires for financial institutions. This has been overtaken, however, by a collaboration between the CDP and the Partnership for Carbon Accounting Financials (PCAF – see below). The CDP will now encourage financial institutions to use the PCAF Standard for measuring and reporting financed emissions and then to include these in their CDP questionnaire responses.7 This harmonization and

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convergence of approaches will help bring greater consistency and comparability to reporting financed emissions, and make such disclosures more accessible to regulators, investors and others reliant on them.

Partnership for Carbon Accounting Financials (PCAF) PCAF8 is a global collaboration between financial institutions (more than 260, totalling more than $70 trillion of assets under management as of June 2022) whose purpose is to develop and implement a harmonized approach to measuring and reporting greenhouse gas emissions from institutions’ lending and investment portfolios. PCAF has published a Global GHG Accounting and Reporting Standard for the Financial Industry, aligned with the GHG Protocol (introduced in Chapter 2, and which covers emissions for all sectors, not just financial services).9 The PCAF Standard provides guidance to measure and report Scope 3, financed emissions for six major asset classes (with further guidance on green and sovereign bonds in development): ●●

listed equity and corporate bonds

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business loans and unlisted equity

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project finance

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vehicle loans

By following the guidance for each asset class, financial institutions can measure and report their greenhouse gas emissions in a consistent and comparable manner. These can then be used to: ●●

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assess and report climate-related risks in line with the Task Force on Climaterelated Financial Disclosures’ (TCFD) latest implementation guidance,10 and support scenario analysis (see Chapter 5); set science-based targets (see below); report to regulators and disclosure bodies (such as the Carbon Disclosure Project (CDP) – described above), investors and stakeholders; and inform financial institutions’ strategies, operations and activities to support their own and their clients’ transitions to low-carbon business models.

QUICK QUESTION Visit the PCAF website to see whether a financial institution you are familiar with has disclosed their financed emissions using the PCAF standard: https://carbonaccountingfinancials.com/financial-institutions-taking-action

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International Sustainability Standards Board (ISSB) In September 2020, the International Financial Reporting Standards Foundation (IFRSF) issued a public consultation setting out how the organization might build on its experience in international accounting standard-setting, its well-established processes and its existing governance structure to develop global reporting sustainability standards.11 This included a proposal to establish a new International Sustainability Standards Board (ISSB), alongside the existing financial reporting board, the International Accounting Standards Board (IASB). Feedback on the IFRSF’s proposals was generally positive and supportive, and the ISSB was launched in November 2021 at COP26. The ISSB aims to develop, in the public interest, a comprehensive global baseline of high-quality climate and broader sustainability disclosure standards to meet investors’ information needs, and will: ●●

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focus on information that is material to the decisions of investors, lenders and other creditors; initially focus on climate-related reporting, while also working towards meeting the information needs of investors on other ESG matters; build upon the work of the TCFD and existing sustainability standard-setting bodies; and combine a global approach to sustainability reporting while providing flexibility where required.12

Since its launch, the ISSB has taken over the work of three existing sustainability standard-setting bodies: the Climate Disclosure Standards Board (CDSB, explored in the reading below), and the Sustainability Accounting Standards Board (SASB) and the International Integrated Reporting Council (IIRC), both introduced later in this chapter. In addition, the ISSB and the Global Reporting Initiative (GRI) have announced that they will seek to coordinate their work programmes and standardsetting activities, although they will remain independent. In March 2022, the ISSB issued its first two draft standards, which – once finalized and approved – will form the foundation for its comprehensive global baseline for climate and broader sustainability reporting: ●●

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Exposure Draft IFRS S1 General Requirements for Disclosure of Sustainabilityrelated Financial Information sets out the overall requirements for the disclosure of significant sustainability-related risks and opportunities.13 Exposure Draft IFRS S2 Climate-related Disclosures builds upon the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD) and incorporates industry-based disclosure requirements derived from the SASB Standards.14

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Building on the work of existing sustainability standard-setting bodies and the TCFD, the ISSB’s draft standards require organizations to set out their approach to: ●●

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Governance: the governance processes, controls and procedures used to monitor and manage sustainability-related and climate-related risks and opportunities. Strategy: approaches used to address sustainability-related and climate-related risks and opportunities that could affect an organization’s business model and strategy over the short, medium and long term. Risk management: the processes used to identify, assess and manage sustainabilityrelated and climate-related risks. Metrics and targets: information used to assess, manage and monitor an organization’s performance in relation to sustainability-related and climate-related risks and opportunities over time, disclosing emissions in line with the Greenhouse Gas Protocol.15

As can be seen from this, the ISSB is not introducing new, innovative climate and broader sustainability reporting requirements; rather, it is consolidating, referencing and re-stating existing approaches and standards. With support from international and national regulatory bodies and other key organizations (including the UN, OECD, IMF, G7, FSB, IOSCO and others), the ISSB’s standards are likely to be increasingly adopted worldwide, bringing greater consistency, comparability and credibility to sustainability reporting, and a basis for global reporting.

READING Climate Disclosure Standards Board (CDSB)16 The CDSB17 is an international consortium of business and environmental NGOs developing mainstream (i.e. financial) corporate reporting so that environmental and social factors are given as much emphasis as financial capital. The CDSB works with the CDP to provide a comprehensive and reliable system for climate, environmental and other sustainability disclosures. The CDP provides a structured approach and detailed guidance for climate disclosures, and a platform for these, whereas the CDSB provides guidance to help organizations communicate these in their mainstream financial reports. The CDSB Framework for reporting is designed to help companies include environmental and social factors in mainstream financial reports and regulatory filings in a consistent and comparable manner. It builds on widely used reporting approaches, including the CDP (in terms of climate and environmental performance)

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and international accounting standards (in terms of financial performance). Including environmental and social factors in companies’ financial reporting should enable investors and others to understand an organization’s sustainability performance, and to compare this with its strategy and financial performance, as well as with the sustainability performance of other organizations. In addition, the Framework supports compliance with regulatory reporting requirements, including current and emerging requirements for sustainability reporting, and is aligned with the recommendations of the TCFD. As of 2021, 374 organizations in 32 countries used the CDSB Framework for reporting. The CDSB Framework does not require (although it does not prevent) the measurement and reporting of Scope 3 emissions. This is because the Framework follows the accounting convention that reporting requirements usually apply to the entity for which financial statements are created, not those that apply to the supply and value chains associated with the entity. This is problematic for financial services, because Scope 3 (financed) emissions are the most significant source of a financial institution’s climate and environmental impact. In 2022, the CDSB was consolidated into the new International Sustainability Standards Board (ISSB). The CDSB’s work and guidance will be incorporated into the ISSB’s Sustainability Standards, while the CDSB Framework and guidance on water, biodiversity and social disclosures will remain relevant for reporting organizations until they are superseded by the ISSB’s new Standards.

QUICK QUESTION What, in your view, might be some of the challenges of monitoring and measuring broader sustainability impacts beyond environmental performance?

Measuring and reporting broader sustainability impacts When measuring greenhouse gas emissions, and reductions in these, capturing accurate emissions data and other indicators at the individual asset or investment level can be difficult, though at least the metrics themselves are generally quantitative, well understood, credible and mostly comparable. When seeking to assess broader sustainability impacts, however, the challenge can be even greater. This is because qualitative judgements relating to broader aspects of sustainability, especially social sustainability impacts – both positive and negative - may have to be made alongside monitoring

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and measuring metrics relating to quantifiable performance. Some impacts may be quantifiable (e.g. the number of jobs lost in a region due to the closure of a coal-fired power station), whilst others may be much harder to quantify (e.g. an improvement in relations with local communities through their involvement as stakeholders in the development and installation of local wind turbines). As we saw in relation to measuring and reporting greenhouse gas emissions and other environmental factors, wherever possible it is important that: ●●

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desired outcomes and impacts are identified at the pre-investment stage (and, ideally, examined by suitably qualified, independent experts); there is regular, ongoing monitoring and reporting through the life of a loan or investment; the measurement and monitoring of impacts and outcomes are verified, ideally by independent review; impacts and outcomes – both positive and negative – are publicly reported.

In a similar vein, the Impact Investing Institute has published recommendations for broader sustainability reporting, proposing that this should: ●●

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include both positive and negative environmental, social and economic outcomes, intended and unintended, that are material to an organization’s ability to create long-term enterprise value, reported in the organization’s main financial statements; include both positive and negative environmental, social and economic outcomes, intended and unintended, that are material to sustainable development, even if they are not yet material for the organization; be subject to assurance that renders all sustainability reporting reliable – assurance for sustainability information in an annual report should be just as robust as that for financial reporting; and be accessible, not only to investors but also to a wider set of users.18

There are several approaches and initiatives that aim to measure, report and compare broader sustainability (often referred to as ‘ESG’) impacts – which include not only climate change and environmental impacts, but also wider impacts, particularly social impacts, which are harder to quantify and measure. Five of these are introduced below. Two of them – the Sustainability Accounting Standards Board (SASB) and the International Integrated Reporting Council (IIRC) – have been consolidated by the new International Sustainability Standards Board (ISSB) introduced above, which will, where possible, build on existing standards, frameworks, guidance and expertise rather than develop its own. As noted, the Global Reporting Initiative (GRI) and ISSB have announced that they will seek to coordinate their work programmes and standard-setting activities, while remaining independent.19 Over time, this consolidation,

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convergence and harmonization of sustainability reporting should bring greater consistency and comparability and improve the credibility and usage of sustainability reporting.

Sustainability Accounting Standards Board (SASB) The SASB is an independent, non-profit organization that sets standards to guide companies’ disclosure of financially material sustainability information to their investors.20 The SASB has published a set of 77 sectoral standards, with each providing guidance on the environmental, social and governance (ESG) issues most relevant to financial performance in each of these industry sectors.21 Seven standards have been published for the financial services sector: ●●

Asset Management and Custody Activities

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Commercial Banks

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Consumer Finance

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Insurance

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Investment Banking and Brokerage

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Mortgage Finance

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Security and Commodity Exchanges

The standards for other industry sectors, though, are equally relevant to financial services firms and finance professionals, as they set out standardized sustainability (in this case, ESG) metrics that investors and others can use to compare and contrast sustainability performance between organizations. By using the standards, investors and others can better identify the risks and opportunities arising from environmental, social and governance issues. As noted above, the SASB will be consolidated by the new International Sustainability Standards Board (ISSB) with the intention of adopting the SASB’s sectoral standards as the basis for the ISSB’s industry-specific requirements as these are developed. As this will take some time, the ISSB and SASB recommend that report preparers and users of the SASB standards should continue to use these.22

International Integrated Reporting Council (IIRC) The International Integrated Reporting Council (IIRC) is a global coalition of regulators, investors, companies, standard setters, the accounting profession, academia and NGOs. The aim of integrated reporting is to explain to investors and others how an organization creates, preserves or erodes value in the widest sense of that term. This is a holistic approach that takes reporting beyond financial matters to consider a wide range of environmental, economic and social factors.23

Measuring and reporting impacts, alignment and flows

The IIRC published its revised International Framework in January 2021, which aims to: ●●

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improve the quality of information available to enable a more efficient and productive allocation of capital; promote a more cohesive and efficient approach to corporate reporting that draws on different reporting strands and communicates the full range of factors that materially affect the ability of an organization to create value over time; enhance accountability and stewardship for the broad base of capitals (financial, manufactured, intellectual, human, social and relationship, and natural) and promote understanding of the interdependencies among them; and support integrated thinking, decision making and actions that focus on the creation of value over the short, medium and long term.24

The Framework does not prescribe specific metrics for impact, as other approaches to sustainability reporting described in this section do. Rather, it adopts a principles-based approach that recognizes the wide variety of metrics that may be relevant to different organizations and sectors. This can make comparability between organizations and sectors difficult, however. In a similar manner to the SASB, the IIRC will be consolidated by the new International Sustainability Standards Board (ISSB). The intention is for the Framework to provide a conceptual basis for connectivity between the IFRS financial reporting and sustainability standards. As this will take some time, the ISSB and IIRC recommend that report preparers and users should continue to use the Framework.25

Global Reporting Initiative (GRI)/Global Sustainability Standards Board (GSSB) The GRI, via its Global Sustainability Standards Board (GSSB), publishes standards for sustainability reporting with the aim of creating a ‘common language’ for organizations – large or small, private or public – to report on their sustainability impacts in a consistent and credible way. This enhances transparency and accountability, supports reporting to regulators and others, and improves comparability between organizations.26 Three GRI standards – GRI 101 (Foundation), GRI 102 (General Disclosures) and GRI 103 (Material Topics) – are described by the GRI as ‘universal’ and apply to all organizations. The Universal Standards provide an overall framework for the Standards. The GRI Sector Standards aim to improve the quality, completeness and consistency of reporting by organizations in sectors with the highest sustainability impacts. These new, sectoral standards aim to cover some 40 sectors in total, with standards for oil, gas and coal already published, and those for agriculture, aquaculture and fishing in development.

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The GRI Topic Standards (more than 30 in total) contain disclosures for providing information on environmental, economic and social factors that are relevant and material to each topic, for example: ●●

Environmental: GRI 304 (Biodiversity), GRI 305 (Emissions)

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Economic: GRI 203 (Indirect Economic Impacts), GRI 207 (Tax)

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Social: GRI 402 (Labour/Management Relations), GRI 405 (Diversity and Equal Opportunity)27

Organizations can use the GRI Standards to prepare their sustainability reports in accordance with the Standards. Alternatively, they may choose to use selected Standards, or parts of the Standards, to report information for specific users or purposes, such as reporting on their impacts on child labour or indigenous peoples. As noted above, the GRI and ISSB have announced that they will seek to coordinate their work programmes and standard-setting activities, although they will remain independent.

Impact Reporting and Investment Standards (IRIS) Developed by the Global Impact Investment Network (GIIN), the Impact Reporting and Investment Standards (IRIS)28 provide a ‘catalogue’ of standardized social and environmental metrics developed for use primarily by impact investors. The IRIS+ Core Metrics provide a framework for producing consistent and comparable data, in the form of KPIs, for assessing the environmental and broader sustainability impacts of investments.29 The IRIS approach includes a thematic taxonomy which sets out generally accepted impact categories across 16 areas, and is aligned with the UN Sustainable Development Goals. One of the thematic areas addresses financial services, and financial inclusion in particular, though other areas (e.g. climate, employment and energy) are also directly impacted by the decisions and activities of financial institutions, and so may also be relevant.

Investment Leaders Group (ILG): Sustainable Investment Framework The ILG is a global network of pension funds, insurers and asset managers committed to advancing responsible investment, supported by the Cambridge Institute for Sustainability Leadership (CISL).30 The ILG’s approach to measuring sustainability impacts, based on the UN Sustainable Development Goals, proposes both ‘basic’ quantitative metrics it believes are relatively straightforward and realistic to assess, and ‘ideal’ metrics or measures that are challenging to measure at present. As we discussed earlier, the ILG notes that, for the most part, environmental impacts are currently more quantifiable than broader sustainability impacts. The ILG identifies six broad impact themes, set out with their ideal and basic metrics in Table 4.2.

Measuring and reporting impacts, alignment and flows

Table 4.2  ILG Sustainable Investment Framework Theme

Ideal measure

Basic measure

Basic needs

Total revenue from products and services addressing the basic needs of low-income groups, adjusted by PPP-weighted International Poverty Line Unit: US$

Total revenue from goods and services from clothing, communications, education, energy, finance, food, healthcare, housing, sanitation, transport and water Unit: US$

Wellbeing

Total tax contribution (comprising taxes on profits, people, production, property and environment but not sales) by country, adjusted by national corruption and spending effectiveness Unit: US$

Total tax contribution Unit: US$

Decent work Total number of open-ended employment contracts, excluding jobs below 60 per cent median wage (living wage) and jobs in poor working conditions (health and safety, discrimination, rights of association), adjusted by national employment rate Unit: number of jobs

Total number of employees based on full-time equivalent (FTE) workers Unit: number of FTEs

Resource security

Hard commodities: Virgin material content of end products (adjusted by scarcity) plus waste lost to the environment (adjusted by toxicity) Soft commodities: Non-sustainably certified content of end products plus waste not specifically returned to nature Unit: metric tonnes (t)

Total net waste (total waste arising – total waste recycled) Unit: metric tonnes (t)

Healthy ecosystems

Area of land utilized by an asset in degraded form Unit: hectares (ha)

Fresh water use (surface water plus groundwater plus municipal water) Unit: cubic metres (m3)

Climate stability

Alignment to future warming scenario based on consumption of global carbon budget Unit: degrees Celsius (°C)

Total greenhouse gas (GHG) emissions (Scope 1 and 2) Unit: tonnes (t) carbon dioxide equivalent (CO2e)

SOURCE  Cambridge Institute for Sustainability Leadership (2019) In Search of Impact: Measuring the full value of capital. Update: Sustainable Investment Framework, www.cisl.cam.ac.uk/resources/sustainable-finance-publications/ in-search-impact-measuring-full-value-capital-update

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The existence of many different approaches to, and organizations involved in, developing standards and guidance for reporting climate, environmental and broader sustainability impacts and outcomes (including those introduced above) should not be surprising, given the breadth of the area as a whole and the fact that many of the approaches have their origins in an NGO or similar organization focusing on a specific area where a gap was identified. The lack of standardization, however, makes consistency and comparability difficult. For these reasons, therefore, the consolidation being undertaken by the new International Sustainability Standards Board (ISSB), encompassing the CDSB, SASB and IIRC introduced above, is an important step towards enhancing the credibility and useability of sustainability reporting. The ISSB’s standards are likely to be increasingly adopted worldwide due to demand from investors and others and as required by regulators in some jurisdictions, although it is unlikely they will become mandatory at the global level (the IFRS financial reporting standards are not). Green and Sustainable Finance Professionals and financial institutions should adopt the ISSB standards wherever possible, though, and should seek to encourage the further harmonization and consolidation of standards where this can improve the consistency, comparability and credibility of sustainability reporting. Green and Sustainable Finance Professionals should also follow developments from the ISSB and other organizations to keep their knowledge of sustainability reporting up to date.

QUICK QUESTION What are the most recent developments in the convergences of sustainability reporting? Visit the ISSB website to find out: www.ifrs.org/groups/international-sustainability-standards-board/

Monitoring the alignment of lending and investment portfolios with the Paris Agreement As we set out above, in the context of green and sustainable finance, monitoring, measuring and reporting can refer to: ●●

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measuring and reporting the environmental and other impacts and outcomes of green and sustainable lending and investment decisions, and other financial activities; monitoring the alignment of lending and investment portfolios, and financing activities overall, with the objectives of the Paris Agreement; and

Measuring and reporting impacts, alignment and flows ●●

tracking and reporting flows of investment to green and sustainable assets, activities, and projects with the aim of meeting the objectives of Article 2.1 (c) of the Paris Agreement and other sustainable goals.

Earlier in this chapter we introduced several approaches and initiatives seeking to bring consistency and comparability to the measurement and reporting of environmental and other sustainability impacts of financial institutions’ lending and investment decisions – particularly financed (Scope 3) greenhouse gas emissions. To achieve global, national, sectoral and institutional net zero targets and ambitions, however, it is not sufficient only to analyse and report those financing decisions related to sustainability. We need to understand and measure the alignment (or lack of alignment) of financial institutions’ overall lending and investment portfolios with the objectives of the Paris Agreement, specifically the objective of keeping global warming to well below 2°C above pre-industrial levels. This is a requirement for financial institutions that are members of the Glasgow Financial Alliance for Net Zero (GFANZ – see Chapter 3) and its constituent Net Zero Alliances. GFANZ members, and other financial institutions that have made similar commitments, must achieve net zero greenhouse gas emissions by mid-century (2050 in the case of GFANZ members) across the entirety of their activities, operations and lending and investment portfolios. More generally, though, consistent and comparable measurement and reporting of lending and investment portfolio alignment with the objectives of the Paris Agreement enables policymakers and others to track progress in climate change ­mitigation activities and to take action, where necessary, to accelerate mitigation and/ or adaptation and resilience measures. For financial institutions and finance professionals, understanding the current and forecast future alignment of lending and investment portfolios helps to assess climate and environmental risks and opportunities and conduct scenario analysis to meet regulatory requirements and support strategic business and investment decision making. In this section, therefore, we introduce two key initiatives to track portfolio alignment with the objectives of the Paris Agreement: ●●

The Science-Based Targets Initiative (SBTi)

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The Paris Agreement Capital Transition Assessment (PACTA)

Most Green and Sustainable Finance Professionals, unless they work directly with the SBTi or PACTA, only need to understand the key principles underlying these approaches – and to follow developments – rather than be able to apply them in detail.

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QUICK QUESTION Has your financial institution, or an institution you are familiar with, adopted and applied the science-based targets and/or PACTA? If so, can you find details of their relevant reports?

Science-Based Targets Initiative (SBTi) The Science-Based Targets Initiative (SBTi) is a partnership between the CDP (introduced above), the United Nations Global Compact, the World Resources Institute and the World Wide Fund for Nature. The SBTi develops ‘science-based targets’ to show organizations by how much and how quickly they need to reduce their emissions to achieve the objectives of the Paris Agreement, setting out decarbonization pathways for key, high-emissions sectors. As of June 2021, more than 1,000 companies, including nearly 60 financial institutions, had set emissions reductions targets through the SBTi.31 The Science-Based Targets provide clearly defined pathways – quantitative targets – organizations can follow to reduce their greenhouse gas emissions. Targets are considered ‘science-based’ if they are in line with what climate science deems necessary to meet the objectives of the Paris Agreement (limiting global warming to well below 2°C, or as close to 1.5°C as possible, above pre-industrial levels). In 2018, the SBTi launched a project to develop science-based targets for the financial services sector, recognizing the influence of financial institutions’ lending and investment decisions over the decarbonization pathways of other sectors and organizations. In April 2022, the SBTi’s initial guidance on science-based target setting for the financial services sector was published. It includes the SBTi’s definition of net zero for financial institutions, and sets the bar high in that such institutions must (a) align all lending, investment and other financing activities with pathways that limit global warming to 1.5°C above pre-industrial levels, and (b) neutralize any residual emissions by financing carbon removal activities. The SBTi’s guidance also states that financial institutions cannot use carbon credits (i.e. offsetting) to align with the 1.5°C target, although they may be used to support residual emissions.32 The SBTi sets out four ‘Guiding Principles’ to help financial institutions achieve net zero as defined above: ●●

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Completeness – financial institutions should set targets that cover all operational and financing activities, including Scope 1, 2 and 3 (financed) emissions. Science-based Ambition – financial institutions should align their financing activities with the latest climate science (limiting global warming to 1.5°C above pre-industrial levels with little or no overshoot) and with the UN Sustainable Development Goals.

Measuring and reporting impacts, alignment and flows ●●

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Real Economy Impact – in recognition of financial institutions’ substantial influence over other organizations and the economy as a whole, they should engage with customers and clients to achieve system-wide decarbonization and a just transition. Decarbonization and Climate Solutions – financial institutions should help existing firms and sectors decarbonize, and should finance the development and scaling of new climate change mitigation technologies, sectors and firms (as we have explored in previous chapters).33

The SBTi’s guidance for the financial services sector also sets out a proposed approach for financial institutions in terms of lending and investment to the fossil fuel sector. The approach is based on the disclosure of current financing activities, engagement with clients on net zero targets and plans, no further financing of new exploration and production, and the end of all financial support to coal by 2030 and oil and gas by 2040. This will have very significant implications for financial institutions with substantial exposure to these sectors. The SBTi notes that its guidance represents a first step in the net zero standard development process for the financial services sector, and that more detailed criteria and guidance are required in the following areas: ●●

the criteria required for financial institutions to claim they are aligned with net zero;

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interim target setting;

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how science-based targets may be applied to different types of financial institutions;

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the role of carbon credits and the financing of carbon credit-generating activities;

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fossil fuel financing (as outlined above).34

The SBTi plans to undertake further work on the above, and Green and Sustainable Finance Professionals should keep abreast of these developments.

Paris Agreement Capital Transition Assessment (PACTA) Developed by the 2° Investing Initiative (2DII), an independent, non-profit organization with a mission to align financial markets with the Paris Agreement goals, PACTA enables investors to measure the alignment of portfolios with climate scenarios.35 It also helps investors implement the recommendations of the TCFD, especially in terms of scenario analysis, and is used by some regulators to assist in assessing the climate risks faced by the organizations they supervise. Currently (April 2022), PACTA is used by more than 3,000 financial institutions in some 90 countries. It has recently been announced that responsibility for maintaining PACTA will be transferred from 2DII to the Rocky Mountain Institute (RMI).36

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PACTA provides a toolkit for analysing investment portfolio alignment across tens of thousands of companies and securities worldwide. It aggregates global, forwardlooking asset-level data (e.g. the production plans of a manufacturing plant over the next five years) on the companies and securities held in a portfolio. It then produces reports that allow investors to assess: ●● ●●

exposure to climate-relevant sectors; how a portfolio is currently aligned with climate scenarios (e.g. 1.5°C of global warming, 2°C of warming, 3°C of warming);

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potential financial losses caused by physical and transition risks;

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exposure to disorderly transition scenarios; and

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which companies and investments have a significant and substantial impact on these results, allowing investors to prioritize action.37

In 2020, PACTA released a similar toolkit for banks, which enables institutions to measure the alignment of their corporate lending portfolios with climate scenarios across a set of key climate-relevant sectors and technologies.38 In a manner similar to that of the PACTA toolkit for investors, it enables banks to assess their exposure to climate-relevant sectors and physical and transition risks, and to understand the extent to which their lending portfolio(s) are aligned with different climate scenarios. It also helps banks conduct scenario analyses to meet the TCFD’s recommendations and evolving regulatory requirements. Furthermore, banks can use PACTA reports to inform future lending decisions and gain insights into key clients and sectors, to engage and support them with their transitions to low-carbon business models. A good example of a bank that utilizes PACTA to support its lending decisions and to help clients develop transition pathways is ING, which in its ‘Terra’ reports (2019/2020)39 and 2021 Climate Report40 uses PACTA for banks to provide clientlevel, forward-looking analysis.

QUICK QUESTION Use the PACTA tool for investors to analyse your own equity portfolio (if you have one), or a portfolio of shares you would like to own. To what extent is it currently aligned with a 2°C or below scenario? https://platform.transitionmonitor.com (registration needed)

Measuring and reporting impacts, alignment and flows

Monitoring, measuring and reporting: tracking flows of climate finance As noted at the start of this chapter, in context of green and sustainable finance, monitoring, measuring and reporting can refer to: ●●

●●

●●

measuring and reporting the environmental and other impacts and outcomes of green and sustainable lending and investment decisions and other financial activities; monitoring the alignment of lending and investment portfolios, and financing activities overall, with the objectives of the Paris Agreement; and tracking and reporting flows of investment to green and sustainable assets, activities and projects with the aim of meeting the objectives of Article 2.1 (c) of the Paris Agreement and other sustainable goals.

In this section, we consider the last of these – how flows of public and private finance are monitored, measured and reported. This is critical for the transition to a sustainable, low-carbon world. The overwhelming majority of activities at both the macro and micro levels (whether government, industrial, business, agricultural, household or individual) involve and require investment from, or the facilitation of, the financial services sector. This can take the form of financing sustainable ‘green’ economic activities, supporting unsustainable ‘brown’ activities and/or supporting the transition of organizations’ business models to lower-carbon methods of production and distribution. As we saw in the previous chapter, the Paris Agreement has three main goals: ●●

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Article 2.1 (a): To hold the increase in the global average temperature to well below 2°C above pre-industrial levels and pursue efforts to limit the temperature increase to 1.5°C above pre-industrial levels, recognizing that this would significantly reduce the risks and impacts of climate change. Article 2.1 (b): To increase the ability to adapt to the adverse impacts of climate change and foster climate resilience and low greenhouse gas emissions development in a manner that does not threaten food production. Article 2.1 (c): To make finance flows consistent with a pathway towards low greenhouse gas emissions (GHG) and climate-resilient development.

It is highly significant that finance is given such prominence in the Paris Agreement. This sends a powerful signal to governments, central banks and regulators, the financial services sector and society that finance plays a central role in addressing climate change mitigation and adaptation and supporting the transition to a sustainable, lowcarbon world. We need to be sure, though, that financial institutions, and the finance

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sector overall, are genuinely redirecting flows of finance from high- to low-carbon sectors and investments, and aligning their strategies and financing activities with the Paris Agreement objectives and broader sustainability goals.

QUICK QUESTION What, in your view, is required to ensure flows of finance are consistent with the Paris agreement targets?

The identification of loans and investments that support environmentally sustainable economic activities is sometimes referred to as ‘green tagging’. Being able to consistently identify and classify economic activities, and the financing activities supporting these, as ‘green’ (and/or ‘brown’ or ‘neutral’) is a key step in monitoring the transition to a sustainable, low-carbon world, with the taxonomies developed by the EU and others enabling this to be done with a greater degree of consistency and comparability than was previously the case. Data on individual loans, investments and the assets underpinning these can be combined to give sectoral portfolio views (such as on the alignment of an institution’s lending to and investment in the transport sector with the Paris Agreement) and ultimately an aggregated, organizational-level view of alignment. Data from organizations can then be further aggregated at the sectoral, industry, national and global levels to track overall progress towards making flows of finance consistent with a pathway towards lower greenhouse gas emissions and climate-resilient development. To assess progress on the alignment of finance with Article 2.1 (c) requires monitoring, measuring and reporting flows of public and private finance, of which there are two key aspects:

Tracking flows of investment to identified climate change mitigation and ­ adaptation projects and activities According to the UNFCCC Standing Committee on Finance, global climate finance flows reached an estimated annual average of $775 billion in 2017–18, as we shall see below. This is only a fraction of the estimated $2.4 trillion required to achieve an energy transition consistent with 1.5°C of warming, or the $6 trillion per year required to meet the Paris Agreement objectives and the UN Sustainable Development Goals as set out in Table 1.1. The UNFCCC’s estimate is, however, almost certainly a substantial underestimate of total climate financing and certainly of the financing of sustainable economic activities overall. At least until recently, the lack of standard

Measuring and reporting impacts, alignment and flows

definitions and reporting in this area made it challenging to identify and assess financial activities supporting climate change mitigation and adaptation. The development of the EU and other taxonomies, and the embedding of market standards such as the TCFD and the Green Bond and Green Loan Principles (see Chapters 6 and 7) are aiding the identification and tracking of green and sustainable lending and investment.

Tracking flows of investment that detract from change mitigation and adaptation projects and activities Achieving the objective of Article 2.1 (c) also requires monitoring and measuring investment and other financial activities that detract from the achievement of the Paris Agreement objectives, for example, the financing of high-carbon power generation or cement production. In some cases, flows of finance to some sectors can be measured directly. We saw in Chapter 1, for example, that between 2016 and 2021 60 of the largest global banks had provided $4.6 trillion of lending and investment for fossil fuels. Monitoring and measuring is more challenging for other sectors, however, and we have seen earlier in this chapter how difficult it can be for financial institutions to measure financed emissions in lending and investment portfolios or through complex supply chains. There are, however, a range of tools and approaches, including the PCAF, that assist in this type of analysis.

The UNFCCC Standing Committee on Finance At the global level, the leading role in monitoring, measuring and reporting flows of climate finance (as opposed to green and sustainable finance more broadly) is played by the United Nations Framework Convention on Climate Change (UNFCCC) Standing Committee on Finance.41 The Standing Committee publishes Biennial Assessments (BA) of global climate finance flows. The most recent was in 2020, using data for the period 2017–18 based on Biennial Reports (BR) submitted in a common format by Annex II Parties (OECD member countries), plus information from Multilateral Climate Funds and Multilateral Development Banks (MDBs). The Standing Committee also seeks to identify and report flows of private and domestic climate finance, noting that data on these is harder to obtain and of poorer quality and consistency, though this is improving. The 2020 Biennial Assessment found that: ●●

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global climate finance flows were 16 per cent higher in 2017–18 than in the previous two-year period (2015–16), reaching an estimated annual average of $775 billion; total global climate finance flows were estimated at $804 billion in 2017, driven by an increase in private investment in renewable energy, but declined to $746 billion in 2018 due to slowdowns in investment in wind and solar power;

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the majority of climate finance in the period 2017–18 supported climate change mitigation activities, although the share of adaptation finance increased from 15 per cent in 2015–16 to 21 per cent in 2017–18, as it grew at a higher rate than mitigation finance; and private finance flows in the areas of renewable energy and energy efficiency substantially outweighed public funding in 2017 and 2018, although the reverse was true regarding financing for sustainable transport.42

The Standing Committee also tracks flows of climate finance from developed to developing countries, and in particular the commitment made by Annex II Parties to provide $100 billion per year by 2020 to developing countries for climate change mitigation and adaptation projects and activities. This increased from $38 billion in 2016 to $45.4 billion in 2017 and $51.8 billion in 2018, but despite these annual increases the 2020 target was not, according to a UN Independent Expert report, likely to be achieved.43

Tracking alignment of flows of finance with the Paris Agreement We saw in Chapter 1 that the private sector has a major role to play in financing the transition to a sustainable, low-carbon world. Approximately 80 per cent of the investment required is anticipated to come from private sources. Private sector climate finance (and green and sustainable finance more broadly) is also needed to help the Annex II Parties meet their commitments to climate change mitigation and adaptation in developing countries. Monitoring and reporting flows of private sector finance is vitally important, therefore, in measuring progress towards these targets and towards the broader objective of meeting the requirements of Article 2.1 (c) of the Paris Agreement. Obtaining good-quality, consistent and comparable data on the flow of private sector finance is challenging, however, as the UNFCCC Standing Committee notes. This is not surprising given the enormous variety of financial institutions, financial instruments and approaches to/definitions of green, sustainable and climate finance in the private sector – despite the many initiatives, some of which we have introduced in this chapter and elsewhere in this book, to bring greater consistency.

OECD Research Collaborative At the global level, the OECD Research Collaborative (comprising governments, research institutions and international finance institutions) aims to improve the

Measuring and reporting impacts, alignment and flows

monitoring of flows of finance supporting the objectives of the Paris Agreement at the institutional, country and international levels by: ●●

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tracking public and private finance flows and assessing their consistency with climate objectives; measuring publicly mobilized private finance for climate action in developing countries; and coordinating ongoing initiatives to improve identification, measurement, estimation and reporting.44

As with the UNFCCC Standing Committee, and as we will examine below, the OECD Research Collaborative identifies the availability, quality, consistency and comparability of data as key challenges, and highlights a number of weaknesses in the data currently available for tracking climate finance flows: ●●

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Existing finance tracking efforts typically focus on specific financial asset classes (for example, bonds or equities), actors (for example, development finance institutions) and/or geographies – but often neglect to combine these to build up a whole picture. While there is an increasing amount of data available in relation to international and multilateral climate finance flows, there is a lack of data on domestic finance flows, such as commercial bank loans and other forms of domestic corporate finance. Most current initiatives focus on tracking finance for climate change mitigation and adaptation activities only. However, assessing progress towards Article 2.1 (c) of the Paris Agreement requires tracking all investments, including those that undermine climate change objectives.45

To overcome such data challenges, it is proposed to focus on monitoring and measuring investment in infrastructure and equipment. This will complement existing efforts to track climate finance, because the production and usage of these accounts for a very large proportion of current and future greenhouse gas emissions.

ISO 14097 The International Organization for Standardization (ISO) has recently developed and published an international standard to support financial institutions and others in measuring and reporting emissions and financial flows – ISO 14097: Greenhouse gas management and related activities – Framework including principles and requirements for assessing and reporting investments and financing activities related to climate change.46

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The ISO is a global network comprising a wide range of international and national standard-setting organizations and associations, and more than 100,000 experts from over 160 countries. It oversees thousands of technical committees that develop and maintain standards across business, industry, science, technology and many other areas. Over the past 10 years, the ISO has developed and published a wide range of standards relating to the environment in general, and to climate change more specifically. These include ISO 14064 for monitoring and reporting greenhouse gas emissions, ISO 14065 for accrediting verifiers of emissions, and ISO 14031 on environmental performance evaluation. In 2021, the ISO announced that it would embed climate considerations into every new standard and retrospectively add these to all existing standards as they are revised.47 The aim of ISO 14097 is to set a global framework for assessing and reporting investments and financing activities related to climate change. This should improve the availability, consistency, comparability and quality of data on climate finance. In turn, this will help financial institutions, regulators, policymakers and governments track and report alignment with and progress towards meeting the objectives of the Paris Agreement.

The data challenge In this chapter, we learned that assessing progress towards achieving the objectives of the Paris Agreement and other sustainability goals requires the development and implementation of credible, consistent and comparable approaches to measuring, monitoring, verifying and reporting environmental and wider sustainability impacts and the outcomes of financing decisions. It also requires measuring and reporting flows of climate finance, and finance that supports sustainability more broadly. As we have seen, issues of data availability, quality and comparability create challenges for finance professionals, financial institutions, regulators, policymakers and others seeking to monitor and report financial flows and impacts. Environmental and other categories of sustainability performance data, however, are becoming ever more widely available – and the quality of data is improving. This includes data from satellites, meteorological flights, weather balloons and other climate/weather monitoring platforms, as well as data gathered by drones, remote sensors linked via the internet and smartphones. The latter are particularly helpful in gathering data from parts of the world where the use of highly expensive, bespoke monitoring systems is unlikely to be feasible. Remote sensing also improves accessibility to data at more granular levels. For example, emissions from a particular factory or power station, or pollutants emitted into a local stream, may be monitored at regular intervals or even in real time where this might be impossible or prohibitively expensive using satellite or airborne monitoring.

Measuring and reporting impacts, alignment and flows

Climate and environmental datasets – once the preserve of national research centres – are now much more accessible. Responding to the needs of central banks, regulators, financial institutions and others for good-quality, accessible data to monitor climate and environmental risks and support TCFD reporting (see Chapter 5), there has been significant growth in the number of data providers offering open source and/or proprietary structured and unstructured datasets, analysis and modelling. This has been facilitated by the falling cost of computing power and the development of advanced data analytics employing artificial intelligence and machine learning techniques. The market for ESG data, and especially climate-related and environmental performance data and analysis, is growing rapidly, with spending on ESG data by financial institutions (mainly) increasing by 20 per cent per year, reaching an estimated $1 billion in 2021.48 Well-known providers include Sustainalytics (see Chapter 9), Arabesque (see Chapter 11) and Carbon Delta (now part of MSCI). Despite this, persistent data gaps remain, according to the Network for Greening the Financial System (NGFS), which in 2021 highlighted the need for data to be more accessible, especially to smaller institutions, and for more forward-looking data (e.g. targets or emissions pathways) and granular data (e.g. geographical data at entity and asset levels). In addition, as the number of datasets and the overall quantity of data increases, greater levels of assurance and verification are required to ensure accuracy and quality.49 To help financial institutions and others access credible, consistent and comparable data on climate and environmental performance, the NGFS has developed an online ‘repository’ (directory) of relevant data sources and providers.50 The repository does not offer direct access to climate and environmental data – many of the datasets are proprietary – but is designed to help financial institutions and others navigate an increasingly complex landscape and provide some limited assurance of quality. The UK’s Climate Financial Risk Forum (CFRF) has developed a similar directory of data providers, and tools/methodologies for using the data.51 To try to overcome issues of data availability and gaps, in 2021 the UK announced the establishment of a Centre for Greening Finance and Investment (CGFI), led by the University of Oxford. The new Centre has been established with the aim of making quality-assured and scientifically robust climate and environmental data and analytics available for any point on Earth historically, in the present, and projected into the future. This will cover every major sector, and the complete spectrum of material climate and environmental factors.52 In turn, this will accelerate the adoption and use of climate and environmental data and analytics by financial institutions and others.

QUICK QUESTION What, in your view, are the advantages of the increasing availability and quality of environmental performance and climate data?

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The combination of improved data availability and quality, and the ability to analyse larger datasets, supports the growth of green and sustainable finance in several ways: ●●

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Improving the accuracy, consistency, credibility and rigour of reporting environmental and social impacts, giving greater confidence to investors and others and helping to avoid greenwashing. Improving the granularity of reporting – for example, by using remote sensors attached to a single source of emissions and linked to a specific loan or investment. Supporting the standardization of data on environmental performance and sustainability, allowing different potential lending and investment decisions to be more easily and effectively compared. Improving the transparency, availability and communicability of reporting, including with data visualization techniques, to make this meaningful to a wider range of non-specialist users. Reducing the costs and time of making lending and investment decisions, thereby reducing the additional costs (compared with ‘vanilla’ financial investments) of environmental and social impact and similar assessments. Enabling real-time monitoring and verification of lending and investment performance in terms of desired environmental and other outcomes, such as by monitoring emissions data or power usage, helping investors manage investments more dynamically.

Perhaps most importantly in the context of tracking the alignment of finance with, and progress towards, the objectives of the Paris Agreement, developments in data availability, quality and analysis enable lenders, investors and others to combine information from multiple – hundreds or even thousands of – sources. This can then be used to gain a more comprehensive overview of the environmental performance and sustainability impacts of lending and investment decisions across whole portfolios, organizations, sectors, countries and regions – and globally. Some believe the development of a global catalogue of every physical asset in the world is already within the reach of technical feasibility.53 The process of identifying and tagging assets (for example, power stations and coal mines) and asset-level features (such as cooling technologies, air pollution control technologies) can be automated using AI, machine learning and other techniques. Greenhouse gas emissions and other environmental metrics can be recorded from each asset or feature, with satellites, drones and other remote sensors generating more accurate, granular and more frequently refreshed metrics. These can then be tied to asset ownership, ultimately enabling investors and others to aggregate data at company, sector, regional or global levels. This opens up the possibility of embedding environmental and sustainability performance data within financial institutions’ real-time decision making. It would also enable progress towards the objectives of the Paris Agreement being tracked with much greater accuracy, in a way that is not possible at present.

Measuring and reporting impacts, alignment and flows

Key concepts In this chapter, we considered: ●●

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how environmental and sustainability performance and impacts can be measured and reported; some of the frameworks and tools commonly used to measure and report impacts, and to identify key organizations and approaches involved; the importance of independent, external review; approaches to monitoring the alignment of lending and investment portfolios with the objectives of the Paris Agreement, including PACTA and the SBTi; the importance and challenges of monitoring, measuring and reporting flows of finance to track progress towards achieving Article 2.1 (c) of the Paris Agreement; and how advances in data availability and analysis can support impact analysis and monitoring flows of finance.

Now go back through this chapter and make sure you fully understand each point.

Review In the context of green and sustainable finance, monitoring, measuring and reporting can refer to: ●●

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measuring and reporting the environmental and other impacts and outcomes of green and sustainable lending and investment decisions, and other financial activities; monitoring the alignment of lending and investment portfolios, and financing activities overall, with the objectives of the Paris Agreement; and tracking and reporting flows of investment to green and sustainable assets, activities and projects with the aim of meeting the objectives of Article 2.1 (c) of the Paris Agreement and other sustainable goals.

Developing, implementing and embedding consistent approaches to measuring, monitoring and reporting the environmental and other sustainability impacts and outcomes of financing decisions is crucial to assessing the alignment of portfolios, financial institutions and the finance sector overall with the objectives of the Paris Agreement and the UN Sustainable Development Goals. Organizations should report both the financial impacts of climate change and other environmental and sustainability factors on their operations and performance,

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and the positive and negative impacts of their activities and operations on the environment and society. This is the important concept of ‘double materiality’. Monitoring systems may seek to measure processes intended to lead to positive green and sustainable outcomes, and/or try to measure the impacts and outcomes of lending and investment decisions. The latter is much more likely to lead to positive environmental and social outcomes and to prevent greenwashing, especially where it includes review by suitably qualified, independent third parties. Several approaches to external review exist, with verification and certification the most credible and robust methods. Standardized approaches and methodologies for reporting environmental and broader sustainability impacts have developed in recent years due to demands from investors, financial institutions, regulators, policymakers and others for consistent, comparable data to help monitor and report impacts of lending and investment decisions. Three key measurement and reporting (disclosure) initiatives seeking to embed a standardized approach to the reporting of greenhouse gas emissions and other aspects of environmental performance are the CDP, the Partnership for Carbon Accounting Financials (PCAF) and the new International Sustainability Standards Board (ISSB). The Sustainability Accounting Standards Board (SASB), the International Integrated Reporting Council (IIRC) and the Global Reporting Initiative (GRI) are bodies that provide standards and other tools to measure and report broader sustainability impacts, including social impacts, which are often harder to measure. The ISSB is in the process of consolidating several existing standard-setting organizations and, in doing so, will bring greater consistency and comparability to sustainability disclosures. To achieve global, national, sectoral and institutional net zero targets and ambitions, including the net zero commitments made by GFANZ members, it is necessary to measure to what extent financial institutions’ overall lending and investment portfolios are aligned with the objectives of the Paris Agreement. Understanding the current and forecast future alignment of lending and investment portfolios helps finance professionals, financial institutions and regulators assess climate risks and opportunities, conduct scenario analysis, and support strategic business and investment decision making. Two key initiatives for track portfolio alignment are the Science Based Targets Initiative (SBTi) and the Paris Agreement Capital Transition Assessment (PACTA). Tracking and reporting flows of public and private climate, green and sustainable finance is also important. Article 2.1 (c) of the Paris Agreement requires parties to make flows of finance consistent with a pathway towards low greenhouse gas emissions and climate-resilient development. This necessitates tracking flows of lending and investment to identified climate change mitigation and adaptation projects and activities, as well as flows of finance that detract from these. At the global level, the leading

Measuring and reporting impacts, alignment and flows

role in monitoring, measuring and reporting flows of climate finance is played by the UNFCCC Standing Committee on Finance, which publishes Biennial Assessments (BA) of climate finance flows. The most recent BA (2020) found that global climate finance flows were 16 per cent higher in 2017–18 than in the previous two-year period (2015–16), having reached an estimated annual average of $775 billion. Issues of data availability, consistency and comparability create challenges for financial institutions, regulators, policymakers and others seeking to monitor and report environmental and sustainability impacts and flows of climate finance. Fortunately, however, environmental and sustainability performance data are becoming ever more widely available, and the quality of data is improving, driven by advances in monitoring and sensing technologies, data analysis and the application of artificial intelligence and machine learning. This is helping financial institutions and others incorporate and embed environmental and sustainability performance data in decision making, modelling and risk management. Table 4.3  Key terms Term

Definition

Annex II Parties

Members of the OECD are required to provide financial ($100 billion per year by 2020) and technical support to the Economies in Transition and Developing Countries to assist them in reducing their greenhouse gas emissions and manage the impacts of climate change.

Article 2.1 (c)

The Paris Agreement has three objectives. Article 2.1 (c) requires Parties to the Agreement to make finance flows consistent with a pathway towards low greenhouse gas emissions and climateresilient development.

Asset-Level Data Initiative (ADI)

A non-commercial, research-based initiative that aims to collect, verify and distribute asset-level data on all companies in key sectors globally.

Carbon dioxide equivalent (CO2e)

The most commonly used measure of greenhouse gas emissions, often expressed in annual CO2e.

Carbon Disclosure The CDP is the most established environmental reporting NGO. It Project (CDP) provides a widely respected and utilized global system of disclosures for nearly 10,000 companies, more than 800 cities and over 130 regions and states, including nearly 300 financial institutions. CDSB Framework

The Climate Disclosure Standards Board (CDSB) Framework is designed to help companies and others report environmental and climate change information in mainstream financial reports and regulatory filings in a consistent and comparable manner. The CDSB and its framework have been consolidated into the newly established International Sustainability Standards Board (ISSB). (continued )

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Table 4.3  (Continued) Term

Definition

Certification

The process by which a loan, investment or other financial activity is measured against recognized external standards and criteria.

Double materiality Identifying and reporting both (i) the financial impacts of climate change and other environmental and social sustainability factors on an organization and (ii) the environmental and social impacts of the organization’s activities and operations on nature and society. External review

A catch-all term covering similar terms such as audit, assurance, attestation, certification, validation, verification and second- or third-party review.

Global Sustainability Standards Board (GSSB)

The GSSB is the GRI’s standard-setting board; it develops and publishes the GRI Standards.

GRI

The Global Reporting Initiative, which publishes standards for sustainability reporting with the aim of creating a ‘common language’ for organizations to report their sustainability impacts in a consistent and credible way. Three Universal GRI Standards provide a framework for the application of GRI Sector Standards and Topic Standards.

ILG

The Investment Leaders Group

Impact monitoring Assessment and evaluation of the impacts and outcomes of investments or operations. International Sustainability Standards Board (ISSB)

A new global standards board, established in 2021 by the International Financial Reporting Standards Foundation. The ISSB will build on existing sustainability standards and frameworks to develop, in the public interest, a comprehensive global baseline of highquality sustainability disclosure standards to meet investors’ information needs.

Framework

The International Integrated Reporting Council. The IIRC and the Framework have been consolidated into the newly established International Sustainability Standards Board (ISSB).

IRIS

The Impact Reporting and Investment Standards, published by the Global Impact Investment Network.

ISO 14097

A new international standard for assessing and reporting investments and financing activities related to climate change. (continued )

Measuring and reporting impacts, alignment and flows

Table 4.3  (Continued) Term

Definition

PACTA

The Paris Agreement Capital Transition Assessment; it is used by more than 1,500 financial institutions to measure the alignment of portfolios with climate scenarios, including Scope 3 financed emissions.

PCAF

The Partnership for Carbon Accounting Financials (PCAF), a global collaboration between financial institutions to develop and implement a harmonized approach to measuring and reporting greenhouse emissions associated with lending and investments. The PCAF has published the Global GHG Accounting and Reporting Standard for the Financial Industry, which includes guidance on reporting Scope 3 financed emissions.

Process monitoring

Assessment and evaluation of an organization’s principles, policies, procedures and practices.

SASB

The Sustainability Accounting Standards Board; it has published a set of 77 industry standards, with each setting out guidance as to the environmental, social and governance (ESG) issues most relevant to financial performance in each of those sectors. The SASB and its standards have been consolidated into the newly established International Sustainability Standards Board (ISSB).

Science-Based Targets Initiative (SBTi)

The Science-Based Targets Initiative provides clearly defined pathways for organizations to reduce their greenhouse gas emissions. Targets are considered ‘science-based’ if they are in line with what climate science deems necessary to meet the goals of the Paris Agreement. SBTi financial sector guidance covers reduction targets for Scope 1, 2 and 3 emissions.

UNFCCC Standing Committee on Finance

The UN body responsible for monitoring, measuring and reporting flows of climate finance.

Verification

Obtaining independent third-party assurance against designated criteria, often including reference to international or market standards and guidance.

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Notes 1 Equator Principles (nd) About the Equator Principles, https://equator-principles.com/ about/ (archived at https://perma.cc/XYH3-JQU2) 2 UNEP (2016) The Equator Principles: Do they make banks more sustainable?, https:// wedocs.unep.org/bitstream/handle/20.500.11822/7482/-The_equator_principles_Do_ they_make_banks_more_sustainable_-2016The_Equator_Principles_Do_They_Make_ Banks_More_Sustainable.pdf.pdf?sequence=3&%3BisAllowed= (archived at https:// perma.cc/236S-AEPF) 3 Macquarie and Green Investment Group (nd) A Guide to the Green Investment Handbook: Assessing, monitoring and reporting green impact, https://www. greeninvestmentgroup.com/assets/gig/who-we-are/our-impact-and-measurement/GreenImpact-Report-English.pdf (archived at https://perma.cc/6YCB-XVAS) 4 Climate Bonds Initiative (2020) How to become an Approved Verifier, https://www. climatebonds.net/certification/become-a-verifier (archived at https://perma.cc/B5B2-XZQS) 5 CDP (nd) Home, https://www.cdp.net/en (archived at https://perma.cc/82XJ-5W3X) 6 Rooke, T (2020) A huge year for climate – and the financial services sector holds the key, CDP, https://www.cdp.net/en/articles/investor/a-huge-year-for-climate-and-the-financialservices-sector-holds-the-key (archived at https://perma.cc/W48S-Q9TU) 7 PCAF (2021) PCAF and CDP enable financial institutions to measure and disclose financed emissions, https://carbonaccountingfinancials.com/newsitem/pcaf-and-cdpenable-financial-institutions-to-measure-and-disclose-financed-emissions (archived at https://perma.cc/2GYA-QJC7) 8 PCAF (nd) Enabling financial institutions to assess and disclose greenhouse gas emissions of loans and investments, https://carbonaccountingfinancials.com (archived at https:// perma.cc/789W-8HTV) 9 PCAF (2020) The Global GHG Accounting and Reporting Standard for the Financial Industry, https://carbonaccountingfinancials.com/standard (archived at https://perma. cc/8K3D-VKVD) 10 TCFD (2021) Implementing the Recommendations of the Task Force on Climate-related Financial Disclosures, https://assets.bbhub.io/company/sites/60/2021/07/2021-TCFDImplementing_Guidance.pdf (archived at https://perma.cc/P9KC-3GU8) 11 IFRS Foundation (2020) Consultation Paper on Sustainability Reporting, https:// www.ifrs.org/content/dam/ifrs/project/sustainability-reporting/consultation-paper-on-­ sustainability-reporting.pdf (archived at https://perma.cc/7U3S-HFHC) 12 IFRS (2021) IFRS Foundation Trustees announce working group to accelerate convergence in global sustainability reporting standards focused on enterprise value, https:// www.ifrs.org/news-and-events/news/2021/03/trustees-announce-working-group/ (archived at https://perma.cc/6NYM-B5AD) 13 IFRS (2022) Exposure Draft and comment letters: general sustainability-related disclosures, https://www.ifrs.org/projects/work-plan/general-sustainability-related-disclosures/ exposure-draft-and-comment-letters/ (archived at https://perma.cc/5GBU-SGY8) 14 IFRS (2022) Exposure Draft and comment letters: climate-related disclosures, https:// www.ifrs.org/projects/work-plan/climate-related-disclosures/exposure-draft-andcomment-letters/ (archived at https://perma.cc/3E37-6ZM5)

Measuring and reporting impacts, alignment and flows 15 IFRS Foundation (2022) Exposure Draft IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information and Exposure Draft IFRS S2 Climate-related Disclosures, https://www.ifrs.org/projects/work-plan/general-sustainability-related-­ disclosures/exposure-draft-and-comment-letters/ (archived at https://perma.cc/ 5GBU-SGY8) and https://www.ifrs.org/projects/work-plan/climate-related-disclosures/ exposure-draft-and-comment-letters/ (archived at https://perma.cc/3E37-6ZM5) 16 CDSB (2022) CDSB Framework for reporting environmental and social information, https://www.cdsb.net/sites/default/files/cdsb_framework_2022.pdf (archived at https:// perma.cc/U8JS-EX7H) 17 CDSB (2022) Home, https://www.cdsb.net (archived at https://perma.cc/57WF-G6VH) 18 Impact Investing Institute (2020) Reporting of environmental, social and economic outcomes, https://www.impactinvest.org.uk/wp-content/uploads/2020/10/Reporting-ofEnvironmental-Social-and-Economic-Outcomes_final.pdf (archived at https://perma.cc/ VBE3-7X3Z) 19 GRI (2022) IFRS Foundation and GRI to align capital market and multi-stakeholder standards, https://www.globalreporting.org/about-gri/news-center/ifrs-foundation-andgri-to-align-capital-market-and-multi-stakeholder-standards/ (archived at https://perma. cc/SLP5-95CC) 20 SASB Standards (2022) Home, https://www.sasb.org (archived at https://perma.cc/ 4FN3-V2MV) 21 SASB Standards (2022) Download SASB Standards, https://www.sasb.org/standards/ download/ (archived at https://perma.cc/SCE8-4FPF) 22 SASB Standards (2022) SASB Standards and the new International Sustainability Standards Board, https://www.sasb.org/wp-content/uploads/2022/03/ SASBStandardsandIFRSF-030222.pdf (archived at https://perma.cc/JF3N-EGK5) 23 Integrated Reporting (2022) Home, https://integratedreporting.org (archived at https:// perma.cc/CLM4-2CP2) 24 IIRC (2021) International Framework, https://integratedreporting.org/wp-content/ uploads/2021/01/InternationalIntegratedReportingFramework.pdf (archived at https:// perma.cc/H5RK-3FN9) 25 Integrated Reporting (nd) About us, https://www.integratedreporting.org/the-iirc-2/ (archived at https://perma.cc/35X2-2TH6) 26 GRI (2022) About GRI, https://www.globalreporting.org/about-gri/ (archived at https:// perma.cc/J3LJ-R8FF) 27 GRI (2016–22) English: GRI Standards, https://www.globalreporting.org/how-to-use-thegri-standards/gri-standards-english-language/ (archived at https://perma.cc/95UV-LYV6) 28 IRIS (2022) Home, https://iris.thegiin.org (archived at https://perma.cc/C8XG-EAGA) 29 GIIN (2019) IRIS+ Core Metrics Sets, https://iris.thegiin.org/document/iris-core-metricssets/ (archived at https://perma.cc/F2DL-Y8UG) 30 Cambridge Institute for Sustainability Leadership (2022) Investment Leaders Group, https://www.cisl.cam.ac.uk/business-action/sustainable-finance/investment-leaders-group (archived at https://perma.cc/CD6N-KF8U) 31 Science Based Targets (nd) Home, https://sciencebasedtargets.org (archived at https:// perma.cc/R3FV-747U)

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Green and Sustainable Finance 32 Science Based Targets (2022) Foundations for science-based net-zero target setting in the financial sector. Version 1.0, https://sciencebasedtargets.org/resources/files/ SBTi-Finance-Net-Zero-Foundations-paper.pdf?utm_source=CP+Daily&utm_ campaign=f0f005a5d0-CPdaily11042022_COPY_01&utm_medium=email&utm_ term=0_a9d8834f72-f0f005a5d0-110340229 (archived at https://perma.cc/Z6P7-E9MW) 33 Ibid 34 Ibid 35 PACTA (2020) Paris Agreement Capital Transition Assessment, https://www. transitionmonitor.com (archived at https://perma.cc/TT3U-6ZSJ) 36 2° Investing Initiative (2022) 2° Investing Initiative transfers stewardship of PACTA to RMI, https://2degrees-investing.org/2-investing-initiative-transfers-stewardship-of-pactato-rmi/ (archived at https://perma.cc/3ZND-TGQ5) 37 Capital Transition Monitor (nd) https://platform.transitionmonitor.com (archived at https://perma.cc/529D-8WB5) 38 PACTA (nd) Bringing Climate Scenario analysis to Banks, https://www.transitionmonitor. com/pacta-for-banks-2020/ (archived at https://perma.cc/QDW8-5T2P) 39 ING (2020) Terra Progress Report 2020: Our approach to climate action, https://www. ing.com/mediaeditpage/2020-ing-terra-progress-report.htm (archived at https://perma.cc/ G979-DQ9H) 40 ING (2021) 2021 Climate Report: Our integrated approach to climate action, https:// www.ing.com/2021-Climate-Report.htm (archived at https://perma.cc/9XMW-F9HY) 41 UN Climate Change (2022) Standing Committee on Finance (SCF), https://unfccc.int/ SCF (archived at https://perma.cc/4ZXG-YGXW) 42 UNFCCC (2021) Fourth (2020) Biennial Assessment and Overview of Climate Finance Flows, https://unfccc.int/sites/default/files/resource/54307_1%20-%20UNFCCC%20 BA%202020%20-%20Summary%20-%20WEB.pdf (archived at https://perma.cc/ 4HEA-AJR2) 43 Independent Expert Group of Climate Finance (2020) Delivering on the $100 Billion Climate Finance Commitment and Transforming Climate Finance, https://www.un.org/ sites/un2.un.org/files/100_billion_climate_finance_report.pdf (archived at https://perma. cc/B9GT-7NNX) 44 OECD (2022) Research Collaborative, https://www.oecd.org/env/researchcollaborative/ about/ (archived at https://perma.cc/YMV7-MYGU) 45 OECD (2019) Tracking finance flows towards assessing their consistency with climate objectives, https://www.oecd-ilibrary.org/environment/tracking-finance-flows-towardsassessing-their-consistency-with-climate-objectives_82cc3a4c-en;jsessionid=nuauzAhD4K 7auRCKVFFjqSXv.ip-10-240-5-153 (archived at https://perma.cc/PA5S-BNS2) 46 ISO (2021) ISO 14097:2021, https://www.iso.org/standard/72433.html (archived at https://perma.cc/47V8-2MVE) 47 ISO (2021) London Declaration: ISO commits to climate agenda, https://www.iso.org/ news/ref2726.html (archived at https://perma.cc/BUQ4-NLL8)

Measuring and reporting impacts, alignment and flows 48 Substantive Research (2021) How to combat greenwashing? Find the right data partners, https://substantiveresearch.com/insights-archive/how-to-combat-​greenwashingfind-the-right-data-partner/ (archived at https://perma.cc/9XMW-F9HY) 49 NGFS (2021) Progress report on bridging data gaps, https://www.ngfs.net/sites/default/ files/medias/documents/progress_report_on_bridging_data_gaps.pdf (archived at https:// perma.cc/AX8R-T47X) 50 NGFS (2022) Data & Resources, https://www.ngfs.net/ngfs-scenarios-portal/dataresources/ (archived at https://perma.cc/T6FM-RXRG) 51 FCA (2022) Climate Financial Risk Forum (CFRF) (Session 2 Guides/Data and tools providers spreadsheet), https://www.fca.org.uk/transparency/climate-financial-risk-forum (archived at https://perma.cc/9XHM-THDE) 52 CGFI (nd) About, https://www.cgfi.ac.uk/about/ (archived at https://perma.cc/ FCA3-QSK3) 53 Spatial Finance Initiative (nd) Geoasset Project, https://www.cgfi.ac.uk/spatial-financeinitiative/geoasset-project/ (archived at https://perma.cc/PF9D-DSWL)

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Risk management Introduction The identification, disclosure and management of climate-related risks – and environmental and sustainability risks more broadly – have become priorities for policymakers, central banks, financial institutions and finance professionals in recent years. Growing awareness of the scale and scope of physical and transition risks and their impacts on countries, communities, economic activities and entities – and financial institutions – has led to a rapidly developing regulatory agenda in this area. These are cross-cutting risks, which affect many other risks faced by financial institutions. In all scenarios, despite efforts to achieve the objectives of the Paris Agreement, the impacts of climate-related and other environmental and sustainability risks will increase due to global warming. In this chapter, we explore key climate-related and broader sustainability risks, introduce a range of approaches to identifying, disclosing and managing these, and discuss emerging regulation in this area. We examine the Task Force on Climaterelated Financial Disclosures (TCFD) and the Taskforce on Nature-related Financial Disclosures (TNFD). Where there are risks, there are opportunities too, especially for financial institutions able to advise and finance clients’ and customers’ transitions to low-carbon, more sustainable business models.

L E A R N I N G OB J ECTI VES On completion of this chapter, you will be able to: ●●

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Describe the nature and importance of key climate-related and environmental risks. Explain the different types of climate-related risks (physical, transition, liability) and their impacts on the finance sector.

Risk management

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Describe the emergence of climate-related and environmental risks as priorities for central banks, regulators and policymakers. Examine approaches to identifying, disclosing and managing climate-related risks, the use of scenario analysis and the evolving regulatory agenda in this area.

Introduction to climate, environmental and sustainability risks There is growing awareness of the current and future impacts of climate change. A decade ago, the World Economic Forum’s (WEF) top global risks included only one risk related to the environment. Today (2022), climate change – and specifically the risk of failing to act on climate change – is identified by business leaders, policymakers, academics and NGOs as the key risk faced by business, finance and society over the next 10 years.1 All of the top five risks identified as likely to materialize were related to climate change and the environment. In addition to climate action failure, extreme weather, biodiversity loss, natural resource crises and man-made environmental damage were recognized as key issues requiring attention by policymakers, regulators, business leaders and others. Table 5.1 shows how awareness of climate and environment-related risks has grown since the signing of the Paris Agreement in 2015. This underlines the extent to which climate, environmental and sustainability risks have become priorities for policymakers, regulators, business and financial institutions. As we will explore in this chapter, these are understood as significant, growing and cross-cutting sources of risk to customers, institutions and the economy overall in the short, medium and long term, and are considered as potential threats to institutional and global financial stability. These are not completely ‘new’ or ‘emerging’ risks, however. The financial risks of climate-related events, such as the costs to insurers and asset owners following extreme weather events such as hurricanes, floods or wildfires, have been apparent for some time, as reflected in Table 5.1. Where there are risks, however, there are also opportunities for investors and lenders in areas such as green infrastructure and energy, clean transport and other climate change mitigation and adaptation technologies, and supporting organizations’ transitions to more sustainable, low-carbon business models. With an estimated $6 trillion of investment per year required to support the transition to a sustainable, low-carbon

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Table 5.1  WEF top five global risks by likelihood: 2016 to date 2016

2017

2018

2019

2020

2021

2022

Involuntary migration

Extreme weather

Extreme weather

Extreme weather

Extreme weather

Extreme weather

Climate action failure

Extreme weather

Involuntary migration

Natural disasters

Climate action Failure

Climate action failure

Climate action failure

Extreme weather

Climate action failure

Natural disasters

Cyber-attacks

Natural disasters

Natural disasters Human environmental damage

Biodiversity loss

Data fraud or theft

Data fraud or theft

Biodiversity loss

Infectious diseases

Natural resource crises

Cyberattacks

Human-made environmental disasters

Biodiversity loss

Human environmental damage

Interstate conflict Terrorist attacks Natural catastrophes

Data fraud or theft Climate action failure

SOURCE  Adapted from Certificate in Climate Risk Study Guide (Chartered Banker Institute, 2022)

Risk management

world, as we saw in Chapter 1, there are substantial commercial opportunities as well as significant risks for many businesses and financial institutions, which we explore elsewhere in this book.

QUICK QUESTION What are some of the key climate-related, environmental and sustainability risks faced by a business you are familiar with? How might these impact banks, investors and insurers exposed to that business?

As we briefly introduced in earlier chapters, risks posed to the financial sector, and to all economic sectors and society as a whole by climate change and other environmental and sustainability factors, can be classified in three ways: ●●

●●

●●

Physical risks arising from the direct impacts of climate-related and environmental hazards on human and natural systems, such as droughts, floods and storms. These impose direct costs on the businesses and communities impacted, and indirect costs through disruption of supply chains. Financial institutions are also impacted, for example through insurance losses and impairments to loans and investments. Transition risks arising from the transition to a low-carbon economy, such as developments in climate policy, new disruptive technologies or changing investor and consumer sentiment. These can lead to increased costs to fund the transition to new, more sustainable business models. For some sectors and firms, the transition to net zero may lead to significant losses in economic value due to impaired or stranded assets. Liability risks arising from parties who have suffered loss or damage from the effects of climate change, environmental damage or negative social sustainability impacts and who seek compensation from those they hold responsible. Some categorize liability risks as a subset of transition risks, but for the purposes of this book we explore them separately, except where the context requires otherwise.

We explore each of these in detail in the next section of this chapter. It is important to understand, however, that in terms of these risks, every future scenario we face includes significantly increased physical, transition or liability risks, or more likely a combination of these. If we fail to tackle global warming and other environmental issues, then physical impacts, including rising surface temperatures and sea levels, extreme weather events and a loss of biodiversity – and the financial impacts associated with these – will continue to rise. The costs of legal action and redress will also

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increase. Achieving net zero by mid-century moderates (without eliminating) climate and environmental hazards, but at the same time creates very substantial transition risks for most, if not all, economic activities and entities. As we saw in Chapter 1, it is estimated that, globally, financial institutions’ lending and investment portfolios overall are currently aligned with more than 3°C to 3.75°C of global warming, substantially in excess of the objectives of the Paris Agreement; this implies that most are currently exposed to significant levels of transition risk if we accept that policy, regulation and societal action will successfully decarbonize the economy. These factors are increasingly driving assessments of financial risk, including potential asset impairment and stranding, at both the institutional and financial system levels. Many of these risks are currently poorly understood and mispriced, and their probability and/or impact underestimated, resulting in significant over-exposure. In addition, the lack of consistent disclosure of these climate, environmental and sustainability risks has made it difficult for decision makers, investors and regulators to monitor, compare and contrast exposure to such risks and take appropriate action. Further on in this chapter we will discuss how central banks and regulators are seeking to co-ordinate and harmonize approaches to climate, environmental and sustainability risks through bodies such as the Financial Stability Board (FSB), which established the Task Force on Climate-related Financial Disclosures (TCFD), the Network for Greening the Financial System (NGFS) and the Task Force on Climaterelated Financial Risks (TFCR), which we introduced in Chapter 3. We will also introduce the recently established Taskforce for Nature-related Financial Disclosures (TNFD), which seeks to address a wider set of environmental and sustainability risks. Climate, environmental and broader sustainability risks may be treated as standalone risks, that is, as risks in their own right (for example, the direct costs of the physical impacts of climate change, and the costs of transitioning to lower-carbon, more sustainable forms of production and distribution). They are also cross-cutting (transverse) risks, which impact many other types of risk faced by organizations, as set out in Table 5.2. Given the cross-cutting nature of these risks, and to make sure the management of these is fully embedded into financial institutions’ strategies and operations, appropriate climate, environmental and sustainability risk governance and risk management structures need to be developed. To be effectively embedded, these must be supported by a culture of climate, environmental and sustainability risk awareness and management that ensures (as we saw in earlier chapters) that ‘every professional financial decision takes account of climate change’. Education and training for risk professionals, and all finance professionals more broadly, plays an important role in developing and sustaining such cultures. This needs to go beyond sustainability specialists and encompass all front-line risk owners (i.e. the majority of finance professionals), as well as risk professionals themselves.

Table 5.2  Climate, environmental and sustainability risks as cross-cutting risks CROSS-CUTTING Climate, environmental and sustainability risk impact areas FINANCIAL/CREDIT

MARKET

OPERATIONAL

REPUTATIONAL

COMPLIANCE/LEGAL

• Loss of collateral/asset value

• Reduced competitiveness

• Higher fossil fuel input costs

• Borrower’s inability to repay loans

• Product obsolescence

• Process inefficiencies

• License to operate called into question

• Access to/cost of capital

• Missing opportunities for new markets

• Irresponsible product stewardship

• Talent acquisition and retention

• Increased cost of regulation and regulatory enforcement

• Equipment end-of-life obligations

• Consumer action and sentiment

• Reduced liquidity

• Third-party civil actions • Lender/investor and insurer liability

SOURCE  UNEP FI (2016) – adapted by author

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Classification of climate, environmental and sustainability risks As we saw above, climate, environmental and sustainability risks can be classified as physical, transition and liability risks, and we explore each in turn below. Some (including the TCFD) categorize liability risks with transition risks, but for the purposes of this book we treat the two separately.

Physical risks Physical risks relate to the material effects of climate change, some of which we are already experiencing. As we saw in Chapter 2, climate change is increasing the frequency and severity of extreme weather events. In many cases, the impacts of these are greater than in the past because of the distribution of the growing global population, and the growth of complex, global supply chains. In the longer term, rising temperatures and sea levels may make parts of our planet uninhabitable. There are quantifiable direct costs associated with physical risks. A severe flood will damage property and infrastructure and disrupt supply and distribution chains and trade. It will leave communities facing substantial clean-up and redevelopment costs. Insurers may cover some or all the direct costs, but economic disruption may continue for months or years. Local businesses and communities may face increased, ongoing costs to fund flood prevention measures. Businesses may decide to relocate, with a loss of jobs and, potentially, knock-on economic effects on other local businesses and commercial/residential property prices. Financial firms that own assets in, lend to or invest in the area may face impairments or losses. Insurance premiums may well rise, and in some cases, assets may become uninsurable, unless there is public sector intervention to share some of the risk with insurers.

The financial implications of physical risks In Chapter 2, we saw that 10 weather-related disasters alone were estimated to have cost more than $140 billion in 2020. In 2021, extreme weather events caused total damage of $280 billion, according to Munich RE2 – an increase of 30 per cent from the previous year and of 70 per cent compared with 2019. Looking ahead, Swiss Re forecasts that the world economy could lose up to 18 per cent of GDP by 2050 if no climate action is taken, with economies in Asia being particularly impacted.3 Limiting global warming to 2°C above pre-industrial levels would still see global GDP fall by 11 per cent, and by 4 per cent if warming is limited to 1.5°C. According to the Intergovernmental Panel on Climate Change (IPCC), global economic damage from the physical impacts of climate change is expected to reach $54 trillion by 2100 with global warming of 1.5°C, and $69 t­ rillion with warming of 2°C.4

Risk management

The costs of physical risks caused by climate change, particularly the increased frequency and severity of extreme weather events, are significant and increasing, both to the individuals, firms and communities directly affected and to the banks, insurers and investors exposed to those risks. In fact, no sector or firm is immune to the physical effects of climate change, not least because of the impacts of physical risks on complex global supply and distribution chains. In assessing the exposure of lending and investment portfolios to climate risks, therefore, financial institutions need to consider not just the direct physical risks faced by office and production facilities, but risks across what are often highly complex value chains. Given the interdependency and ‘just-in-time’ nature of many of these, an event in one location can severely disrupt production and sales on the other side of the world, as the many examples of global disruption caused by the Covid-19 lockdowns have demonstrated. In November 2020, the Financial Stability Board (FSB) concluded that, whilst at present physical risks do not appear to be having a significant impact on asset valuations (i.e. the physical risks of climate change are already priced in), there is a considerable downside ‘tail risk’ – a risk that, whilst currently considered improbable, might in the future crystallize. Without robust climate risk management, the FSB is concerned that physical and transition risks (the latter is covered below) could combine, leading to an amplification and acceleration of financial instability.5 The Task Force on Climate-related Financial Disclosures (TCFD) divides physical risks into: ●● ●●

Acute risks: with severe, short-term impacts such as floods or hurricanes. Chronic risks: with more gradual, longer-term impacts such as rising sea levels or surface temperatures.

The former, as we can see in the aftermath of many extreme weather events, lead to significant short- and medium-term costs for clean-up, redevelopment and building more climate-resilient infrastructure, costs often borne by insurers and other parts of the financial services sector. Coastal communities, industrial areas and seaports are the most likely to suffer from climate change, and, as we saw in Chapter 2, rising temperatures and sea levels may make parts of our planet uninhabitable. This would result in significant asset stranding, and in costs of relocating and redeveloping existing facilities. According to research by C40, even if global warming is limited to below 2°C above pre-industrial levels, over 570 low-lying coastal cities will be at risk from rising sea levels by 2050. This means that some 800 million people living in major low-lying cities – including Amsterdam, Miami, Osaka and Shanghai, and financial centres such as London and New York – will be significantly affected.6 We must also recognize the impacts on many coastal communities in the developing world, whose people are the least responsible for climate change but in many cases may be amongst those most impacted by its effects. Not all

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regions or areas, however, will necessarily suffer the same net effects of climate change or be impacted in the same ways. As we saw in Chapter 3 and throughout this book, global and national policy, regulatory and societal responses aimed at reducing greenhouse gas emissions and achieving net zero by 2050 have accelerated since the signing of the Paris Agreement in 2015. Green and Sustainable Finance Professionals will need to consider how effectively such policies are being translated into action, and therefore to what extent physical risks such as those discussed above will crystallize – and what the impacts of these will be on lending and investment portfolios and risk appetite. It is important to remember, though, that even if the objectives of the Paris Agreement are achieved, global warming will still increase from current levels, and the physical impacts of climate change will still become more marked and more disruptive. Uncertainty caused by differences in the development and implementation of national climate, economic and energy policies creates additional risks. This uncertainty is compounded by the complex, systemic nature of climate change and its links with broader categories of environmental and social sustainability risks, as we examined in Chapter 2. This means the precise impacts of climate change are extremely difficult to predict, and it is hard to state with certainty what the future will hold. As we saw in Chapter 2, however, the most recent (2021/22) IPCC reports make clear that global temperatures are likely to rise by more than 1.5°C above pre-industrial levels by mid-century, and that some of the impacts of that warming are likely to be inevitable and irreversible, including the warming of the oceans, the melting of Arctic ice and the rise in sea level.

QUICK QUESTION Which physical risks are highest for your organization? What strategies could you put in place to minimize and/or mitigate these risks?

Transition risks Transition risks are those risks that arise from the transition to a low-carbon economy. The TCFD divides these into four types, which we explore in turn in this section: ●●

Risks from developments in climate policy, legislation and regulation: for e­ xample, the introduction of carbon pricing may increase a coal or gas-fired power station’s operating costs, reduce its profit margin and potentially lead to early decommissioning.

Risk management ●●

●●

●●

Risks from new, lower-carbon technologies which substitute for existing products and services; for example, renewables replacing fossil fuels or electric vehicles replacing petrol and diesel vehicles. Risks from changing consumer behaviour and investor sentiment, leading to changes in demand for products and services (for example, increased demand for plant-based foods and reduced demand for meat) and in investment demand (e.g. a fall in demand for assets heavily dependent on fossil fuels). Reputational risks where organizations (and, potentially, whole sectors) may suffer from their association with high-carbon methods of production and distribution, environmental destruction or causing social harm. This may lead to falling demand and revenues, and reduced attractiveness to potential employees and investors.

The implications of the global transition to net zero are systemic for all sectors and all firms, for to achieve the objectives of the Paris Agreement every economic activity and entity will need to reduce (and/or offset) greenhouse gas emissions to a greater or lesser extent. Consumer demand for high-carbon goods and services will fall substantially. Firms will also face increased costs from carbon pricing and other forms of climate and environmental regulation. Some sectors and firms will face an existential threat unless they radically – and rapidly – transform their business models in response to transition risks. This, of course, poses very real risks to the financial institutions that lend to or invest in such sectors and firms. It also offers an opportunity to help these sectors and firms finance successful transitions. The nature of the transition to net zero itself impacts on the risks organizations face. An orderly transition, aligned with the objectives of the Paris Agreement and supported by national and sectoral plans and policies to achieve net zero by midcentury, does not reduce the scale and scope of transition risks, but at least makes them – and their financial implications – broadly predictable. A disorderly transition where governments and others are forced into taking swift action in response to, or to avoid, catastrophic climate change could lead to a ‘climate Minsky moment’. This refers to a rapid system-wide adjustment and an abrupt re-pricing of high-carbon assets that would have significant impacts on the many organizations and communities and financial institutions exposed to them. A disorderly transition would threaten national and global financial stability. There are already examples of how disruptive changes, linked to policy, technology, consumer preferences and other economic factors, can indeed cause sharp changes in valuations. Kodak and Blockbuster are examples of firms that failed to transform their business model to adjust to such changes, and no longer exist. In both cases, this was due to new, digital technologies superseding existing camera and video technologies. The transition to net zero is already having a similar, disruptive effect, especially on the coal mining sector in some countries and regions. The combined

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market capitalization of the top four US coal producers fell by 95 per cent between 2010 and 2015, for example, with three of the top five US firms filing for bankruptcy.7 Transition risks impact financial institutions, as well, as they are exposed through investment and lending to a wide range of sectors and firms across the world, all of which will be affected (both positively and negatively) by the transition. Banks’ balance sheets may be substantially impaired by lending to high-carbon firms and sectors. Investors’ and insurers’ portfolios may be significantly reduced in value if they are aligned with more than 1.5°C or 2°C of global warming (as is currently the case for the majority). The risks to financial institutions are increased if there is a disorderly transition, for there will be little time to adjust portfolios, and high-carbon assets could be substantially impaired or stranded, with significant consequences for financial institutions and financial stability overall.

Transition risks: political and regulatory Political and regulatory risks are closely linked (a change in government may lead to new policy and regulatory priorities) but are distinct. Rapid changes in the political climate, which may be related or unrelated to climate change and the transition to a low-carbon world, increase uncertainty to long-term lending and investment decision making. Whilst many countries have set net zero targets consistent with the objectives of the Paris Agreement and other environmental objectives, these are not universal or binding on future governments should political priorities alter. The transition to a low-carbon world requires long-term commitments which many governments can find hard to make, given the relatively short lifespan of many political administrations, at least in democratic countries. In the United States, for example, the 2016–20 Trump administration was highly sceptical about climate change, resulting in the US withdrawing from the Paris Agreement, increasing investment in domestic fossil fuel extraction, and softening environmental protection regulation. These changes in policy are estimated to have added some 1.8 gigatonnes of CO2e to the atmosphere by 2035.8,9 Under the Biden administration, the US has re-joined the Paris Agreement but now faces a greater risk of a disorderly transition, with less time available to achieve net zero. In order to do so by mid-century, the US must reduce annual greenhouse gas emissions by 5.4 per cent, which seems unlikely at the current pace of change. Political risks are related to market risks, such as changing consumer behaviour. Campaigning by environmental NGOs and others often seeks to influence political views (and hence policy and regulation), as well as to encourage individuals to change their behaviour and use consumer/financial pressure to promote change. An emerging political risk for the finance sector is that, as the physical effects of climate change become increasingly apparent, support for alternative and more radical political

Risk management

approaches may increase. This could target the financial services sector as being ‘part of the problem, rather than part of the solution’. Regulatory risks are a subset of political risks; they encompass changes to legislation and regulation that could have a direct effect on the value of loans and investments, and on the activities of financial institutions more generally. These go beyond the regulatory risks associated with the introduction and evolution of financial regulations designed to address climate change and broader categories of environmental and social sustainability risks, and include the following: ●●

●●

●●

●●

●●

climate change and environmental protection regulations (and incentives) promulgated by a wide range of government departments such as agriculture, energy and transport; local (municipal) government regulations that may affect activities encouraged or disincentivized in local areas; taxation regimes, especially the introduction of carbon taxes and other forms of taxation to incentivize low-carbon investment and consumption, and disincentivize high-carbon alternatives; renewable energy, energy efficiency and other incentives and subsidies being introduced or withdrawn; regulations designed to incentivize or disallow certain categories of activities.

Regulatory developments designed to encourage sustainability and/or the disclosure of climate-related risks may also offer opportunities for financial institutions and Green and Sustainable Finance Professionals. These can include offering capital relief for green and sustainable lending, or stimulating the growth of new markets and low-carbon industries through subsidies, as in the case of solar and wind power. In many cases, regulation designed to mitigate the effects of climate change and support the transition to a low-carbon economy is based on the internalizing of externalities related to climate change and environmental degradation. A good example of this is carbon pricing, which we consider later in this chapter. An analysis by the consultancy Vivid Economics and the Principles for Responsible Investment found that the rigorous introduction of climate policy and regulation consistent with the objectives of the Paris Agreement would reduce the valuation of the 1,400 publicly listed companies in the MSCI ACWI index by between 3.1 and 4.5 per cent ($1.6 to $2.3 trillion). There would be significant variation within this; the 100 worst-performing companies would lose some 43 per cent of their value, approximately $1.4 trillion. The 100 best performers, however, would benefit from gains of around 33 per cent of their current value, equivalent to some $1.7 trillion, demonstrating that there are opportunities to be gained from transition, too.10 As we discuss elsewhere in this book, successfully tackling climate change and other environmental issues involves time horizons that are longer than those normally

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associated with many lending and investment decisions. Regulatory certainty is an important part of this; if firms, and their investors and lenders, do not have reasonable certainty that the policy and regulatory landscape (especially related to permitted activities, incentives and subsidies and taxation) will remain relatively stable over time, this increases risk and therefore disincentivizes investment.

Transition risks: technology Technology risks occur when new, lower-carbon (or other) technologies replace existing products and services, which may lead to the impairment or stranding of assets. This is by no means unique to green and sustainable finance; the introduction of music streaming services led to sharp declines in the sale of CDs and in the value of record companies, for example. We noted the well-known examples of Kodak and Blockbuster above. What is perhaps unique to the green and sustainable finance sector is the potential scale of substitution and asset impairment and stranding because of the transition to a low-carbon world. This net zero transition will impact almost every economic activity, and every economic entity, to a greater or lesser extent – it is a ‘whole economy transition’. A successful transition from a high-carbon to a low-carbon world will mean the substitution of a wide range of products and services built using existing technologies, including, but not limited to: ●●

energy

●●

transport

●●

petrochemicals

●●

construction

●●

agriculture and food

●●

clothing

●●

consumer appliances

This will have a substantial impact not only on the producers of high-carbon goods, but also throughout their supply and distribution chains. Whilst we might perceive that the transition to a sustainable, low-carbon world is proceeding slowly overall, in individual cases the effects of that transition may be dramatic. They can be especially sudden when prompted by changes in regulation, such as to prevent the sale of new petrol- or diesel-powered cars by 2025 (as in Norway) or 2030 (in the UK). This is already having an impact on car manufacturers and their supply chains, as well as on many other parts of the automotive value chain, for example car dealerships and petrol stations. Financial institutions exposed through lending and investment portfolios to both electric and petrol/diesel-powered vehicles are in turn also experiencing positive and negative impacts from the transition.

Risk management

QUICK QUESTIONS How vulnerable are some products and services you use to substitution by lowcarbon alternatives? What would cause you to switch?

Transition risks: changing consumer preferences and social norms Risks from changing consumer behaviour and social norms lead to changes in demand for products and services (for example, an increase in plant-based foods and a decline in meat consumption) and in investment demand (such as a decline in demand for assets heavily dependent on fossil fuels). These are linked to the political, regulatory and technology risks previously discussed in this section, and to the reputational risks discussed in the following section. The distinction comes in the fact that changing consumer behaviour (e.g. a reduction in demand for products containing palm oil from non-sustainable sources) and investor sentiment (such as reducing investment in traditional car producers and increasing investment in electric vehicle manufacturers) may depend less on the observable impacts of climate change, changes in legislation and regulation and the transition to a low-carbon economy overall, and more on consumer and investor perceptions of the potential benefits, costs and impacts of certain behaviours. If changing perceptions lead to changes in consumer behaviour, this can positively or negatively affect demand for particular goods and services, impact the value of the organizations that provide them, and in turn affect the financial institutions exposed through lending, investment and other finance activities. If changing investor sentiment leads to a greater or lesser appetite for risks, in this case environmental and climate-related risks, this may in turn lead to changes in asset allocation, diversification or disinvestment from certain companies or sectors, or to greater or lesser decarbonization of portfolios more generally. Finance itself can play a role in changing behaviour and social norms within the financial services sector. One way to do this is to encourage and incentivize firms to decarbonize by divesting, or threatening to divest, from firms or sectors perceived as being major emitters of greenhouse gases. We briefly introduced Climate Action 100+ in Chapter 3, for example, and will look at this in more detail in Chapter 9. In 2020, the UK’s largest pension fund, the National Employment Savings Trust (NEST), began to screen out any company involved with coal mining, oil from tar sands and arctic drilling. In 2016, Peabody, then the world’s biggest coal company, announced plans for bankruptcy, claiming that a major factor in its decision was the impact of the divestment movement, which had made it difficult to raise the capital it needed from

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banks and investors to continue operations. Financial institutions can also help shape individuals’ consumption decisions and encourage more sustainable behaviour by, for example, integrating carbon tracking and scoring into retail banking and investment apps and platforms, some examples of which we will explore in later chapters.

QUICK QUESTION What changes (if any) have you, your family and friends made to your consumption choices to reflect the need to reduce greenhouse gas emissions?

Transition risks: reputational Reputational risks arise where organizations (and, potentially, whole sectors) suffer from being associated with high-carbon methods of production and distribution and other environmental harms. These can lead to falls in brand value, reduced demand for goods and services, decreased revenues, increased costs of crisis management and resolution, and reduced attractiveness to potential customers, employees and investors. Reputational risks may also arise in relation to a range of broader social sustainability factors, such as using child or forced labour. Financial services firms can find themselves suffering reputational (and financial) damage if they are seen to be supporting organizations and sectors that contribute to global warming or cause other environmental or social harms – even if their own operations, within themselves, are highly sustainable. Reputational risks also arise when organizations are accused of greenwashing, some examples of which were discussed in earlier chapters (such as Volkswagen installing ‘defeat device’ software in diesel vehicles). This may lead to activist and consumer campaigns and boycotts, with falling revenues and profitability. This is a significant issue in financial services since, despite increases in the capital they deploy to support green and sustainable finance investments and activities, many financial institutions still provide substantial investment to high-carbon sectors. As we noted in Chapter 1, for example, 60 global banks have provided financing of more than $4.6 trillion to fossil fuel companies since the signing of the Paris Agreement in 2015, according to the Banking on Climate Chaos 2022 report.11 Similarly, companies and financial institutions that are perceived to be lobbying to block or delay legislation or regulation designed to address climate, environmental and social issues may also face reputational risks. In 2020, for example, the investment firm Storebrand publicly disinvested from Rio Tinto, ExxonMobil and Chevron after learning they had lobbied against legislation aimed at supporting the transition to net zero in the United States.12

Risk management

Climate activists, NGOs, journalists and bloggers are increasingly investigating and disclosing the financing of oil, gas, coal and similar activities, especially where this stands in contrast to financial institutions’ public pronouncements on climate change and sustainability. Increasingly, signs of greenwashing from financial institutions can lead to mistrust, internally within organizations as well as externally. Hannah Duncan, a financial blogger, for example, writes: Big banks and asset managers can invest billions into sustainability, but when they continue to finance fossil fuels, it means nothing… We’ve got to wake up to the reality. We cannot call ourselves sustainable if we’re building new oil pipelines and cutting down forests. We finance people need a reality check.13

With significant economic value attached to intangible assets such as brands and goodwill, reputational damage can impact revenues and profitability; it can also affect the value of an organization and its attractiveness to lenders, investors and potential employees.

QUICK QUESTION Which organizations are you aware of that have been targeted by NGOs and others for alleged greenwashing?

Liability risks As noted above, the TCFD and others treat liability risks (also referred to as ‘litigation risks’) as a subset of transition risks, since these – at least in part – arise from the development of stricter climate and environmental legislation and regulation. For the purposes of this book, however, we treat these separately, as this is a broad and growing category of risk. As of April 2022, almost 2,000 lawsuits relating to climate change and environmental issues have been filed in more than 40 jurisdictions, including the US, Australia, the UK, the EU, New Zealand, Brazil, Spain, Canada and India.14 Liability risks include costs that arise from: ●●

●● ●●

●●

legal claims (litigation) prompted by poor environmental management (for example, discharging chemical waste into a river); claims against emitters of greenhouse gases and other harmful pollutants; legal challenges led by activists seeking to pressure companies and governments to do more to prevent climate change and protect the environment; and failures by companies and investors to take adequate account of the risks of climate change and other environmental factors.

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The direct costs of legal action can be significant. The costs arising from changes in legislation, regulation (or sentiment) as a result of such action, however, may be much greater. For example, when a ‘polluter pays’ principle is established or upheld, this may lead to a re-pricing of assets and, in some cases, to significant impairment or stranding. Firms and sectors can face substantial long-term costs as a result of litigation. The Polish state-controlled energy group Enea, for example, was taken to court by ClientEarth (see the case study below) over its decision to construct a new coal-fired power plant. The decision was declared invalid, and construction could not go ahead – imposing significant costs on Enea, and its investors and lenders, beyond the direct costs of the legal action itself, damaging the company’s reputation with consumers and investors, and setting a precedent that would limit the likelihood of similar future projects by Enea or others going ahead.15 Similarly, in January 2021, Royal Dutch Shell was ordered to pay damages to farmers in Nigeria following two oil pipeline spills that occurred more than a decade previously.16 The resulting pollution had caused severe environmental harm, devastating local farmers. The wider implication of the case is that it may set a precedent that oil companies and others have a Duty of Care, a legal prerequisite for claimants to sue for negligence. This could lead to many new cases arising, and to changes in operating models and the economic rationale for future investments. Litigation, therefore, can have an impact well beyond the direct financial costs involved. It can also be a driver of regulatory reform, and of corporate strategy and governance. As we explore in the case study below, claimants may seek to deploy litigation as a strategic tool, recognizing the value of even unsuccessful litigation as a mechanism that can be used to: ●●

raise the profile of a particular issue;

●●

obtain the defendant’s internal documents or information;

●●

impact a corporation’s social licence to operate (for example, the ‘Make Big Polluters Pay’ campaign17 launched by a coalition of environmental NGOs);

●●

raise potential defendants’ costs; and

●●

apply pressure on governments to introduce relevant regulation.

CASE STUDY ClientEarth18 ClientEarth is an environmental law charity that uses the power of law to tackle climate change. The charity operates in three main ways: 1 Shaping the law – for example, collaborating with the Chinese government to build an environmental legal system.

Risk management

2 Enforcing the law – as of February 2021, the charity has 169 active cases. 3 Increasing access to environmental law – for example, empowering local communities in West and Central Africa to enforce forestry laws. By using the law to fight climate change (among other environmental and social issues), ClientEarth holds companies and governments to account for their actions. In 2017, the charity was named the ‘UK’s most effective environmental organization’ by the Environmental Funders Network. ClientEarth is serious about green and sustainable finance, particularly in relation to climate change. The charity draws attention to banks and other financial institutions that it believes are not deemed to be conducting business in a way that is aligned with their climate commitments. To date, ClimateEarth has reported four major UK companies and three insurers over failures to adequately address climate change risks in their annual reports. This puts pressure on firms – and their professional advisors – to improve their disclosure (and ultimately, management) of climate risks.

Climate, environmental and sustainability risk management in practice Risk is defined by the International Organization for Standardization (ISO) as ‘the effect of uncertainty on objectives’, and risk management as ‘the identification, evaluation and prioritization of risks, in order to minimize the probability or impact of negative events’.19 Risk is a central consideration for finance professionals when considering lending, investment and other financial decisions, for there are a wide variety of risk factors that can have an impact on expected returns. Some risks may materialize over the term of a loan, investment or other financial activity, some may increase or decrease in materiality, and new risks may emerge. When considering and monitoring the ongoing performance of lending, investment and other financial decisions, therefore, financial institutions and finance professionals undertake detailed risk assessments in areas including: ●●

country, political and regulatory risk

●●

credit risks

●●

financial risks

●●

legal risks

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market risks

●●

operational risks

●●

technical risks

●●

climate, environmental and sustainability risks

In many traditional risk assessments, although climate, environmental and other sustainability risks may form part of the overall assessment process, the primary focus is often on shorter-term, narrower, more easily quantifiable risks. As we have seen earlier in this chapter, however, these risks, and especially the physical, transition and liability risks of climate change, can and do have very significant short-, mediumand long-term impacts. Furthermore, they are cross-cutting (transverse) risks that affect many of the other risk types listed above. Financial institutions’ strategies and activities are both informed by, and respond to, the identification and assessment of risk across all categories, including climate, environmental and sustainability risks. A strategic approach to risk management is developed through firms’ risk governance frameworks, risk management systems, controls and reporting, and the setting of appropriate risk appetites. As Figure 5.1 illustrates, these are interlinked, informing and reinforcing each other. Risk strategy: Provides an overarching approach for the acceptance and management of risks within an organization, and is usually approved (certainly in financial institutions) by the main board of directors or a similar body. In terms of climate, environmental and sustainability risks, this means boards should be aware of and consider the actual and potential impacts of physical, transition and liability risks and opportunities on their businesses, strategies, and financial planning over short-, medium- and long-term time horizons. Risk governance: Governance refers to the actions, policies, processes, procedures, structures and traditions by which authority is exercised and decisions are taken Figure 5.1 Risk management chart – strategy forecasting, governance and risk appetite Strategy and forecasting

• • • •

Oversight Policies and procedures Governance Transparency Risk committees

• Regulatory and internal-driven scenarios • Strategic planning • What-if analysis

Risk appetite

• Regulatory and climate-driven scenarios • Setting climate risk limits and RAROC pricing • Capital allocation

Risk management

and implemented. Risk governance applies the principles of good governance to the identification, assessment, management, reporting and communication of risks within an organization. It incorporates accountability, participation and tran­ sparency in establishing sound mechanisms to make and implement effective riskrelated decisions. A sound risk governance framework promotes clarity and understanding of the ways in which an organization’s employees execute their responsibilities. Given the significant impacts of climate, environmental and sustainability risks and opportunities, and their cross-cutting (transverse) nature, firms’ risk governance frameworks must be designed to ensure that those risks are appropriately assessed and evaluated at all levels of the organization. Risk appetite: Defines the level(s) of risk an organization is willing to take to achieve its strategic and commercial objectives. A clearly articulated risk appetite helps firms, and financial institutions especially, properly understand, monitor and communicate the organization’s overall approach to climate, environmental and sustainability risks, both internally and externally. A properly embedded risk appetite is a way of approaching risk within an organization that is broadly understood by colleagues at all levels, not just directors, executives and risk managers. As we have seen in this chapter and throughout this book and course, climate, environmental and sustainability factors are major drivers of risk and opportunity, and their cross-cutting (transverse) nature means they impact many areas of a firm’s risk appetite.

QUICK QUESTION Are you aware of the risk appetite statement of the financial institution you work for, or for an organization you are familiar with? What, if any, reference does it make to climate, environmental and sustainability risks?

Setting an appropriate risk appetite, and establishing robust risk governance frameworks, risk management systems, controls and reporting, are necessary conditions for ensuring that financial institutions take account of, and can respond to, the risks and opportunities of climate change, environmental and broader sustainability factors. To fully embed climate and sustainability risk awareness and management within the organization, though, firms also need to develop and embed strong risk cultures consistent with this goal. As we explored in Chapter 3, at the organizational level, culture can be cultivated and sustained through the role of leadership (‘tone from the

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top’), appropriately aligned incentives and remuneration, and relevant education and training. Regarding the last of these, the Chartered Banker Institute, the Chartered Insurance Institute and the Chartered Institute for Securities and Investment have developed the benchmark Certificate in Climate Risk to help risk and finance professionals build and embed appropriate and robust approaches to climate and sustainability risk management within their organizations.20 In the case study below, we examine how one international financial institution, ING, approaches the governance and management of climate risk. ING also considers environmental and broader sustainability risks, but as we will discuss in more detail below, these are emerging priorities for financial institutions, policymakers and regulators, and practice in these areas is, at present, less developed.

CASE STUDY ING’s approach to climate risk management21 ING is a universal bank based in the Netherlands, with strong European retail and wholesale banking franchises and operations in more than 40 countries. With total assets of approximately $1.1 billion and 58,500 employees (2021), it is one of Europe’s larger banks. ING is a founder signatory of the UN Principles for Responsible Banking and is widely seen as one of the European leaders in the financial sector’s response to climate change and sustainability in general, and a pioneer in terms of disclosing climate and environmental risks. ING’s Climate Report 2022, for example, now integrates the bank’s TCFD-aligned risk disclosures with its progress on decarbonizing its financing activities and alignment with the objectives of the Paris Climate Agreement (these were previously reported separately). Risk governance In 2018, ING formed a Climate Change Committee, chaired by the bank’s chief risk officer (CRO), to ensure that climate risks and opportunities were included in risk management and decision making at the executive level. Members included ING’s chief financial officer and senior executives from the retail and wholesale banking divisions. The Committee was responsible for strategic oversight in this area, and for developing and overseeing policies, performance objectives and monitoring in relation to climate risks and opportunities. This approach was updated in 2022 to integrate sustainability (ESG) governance with the existing business-as-usual governance of the bank, at all levels. This included replacing the Climate Change Committee with a new ESG Committee at Supervisory Board level, and all senior executives now have sustainability-related key performance indicators, which in turn are cascaded

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through their business lines. ING’s Global Head of Sustainability now reports directly to the bank’s CEO, and sustainability/ESG leads in major countries report to them. ESG risk governance at ING is mainly managed via three risk functions: 1  Environmental and Social Risk (ESR) : acts as the first line of defence, responsible for setting ING’s ESR framework, which helps business lines decide how, where and with whom the bank does business based on an assessment of environmental and social risks in those business areas, among other factors. This applies to all ING business lines and the primary responsibility for its application lies with this function. 2  Climate Risk : sponsored by ING’s CRO, this function aims to address climate and environmental risks across the bank. A series of workstreams are responsible for areas, including risk identification, business strategy and governance, risk appetite and external disclosures. 3  ESG Risk Centre of Expertise: reporting to ING’s CRO, this function will develop the bank’s over-arching ESG risk framework and policies, set risk appetite statements and co-ordinate internal and regulatory stress-testing and scenario analysis. Risk Management ING’s integrated climate approach considers how the bank can mitigate climate change through its financing activities, as well as how climate change may adversely impact its business. Both physical and transition risks could impact ING’s balance sheet and profitability, so a comprehensive process has been implemented to identify and understand these risks and integrate them into the bank’s businessas-usual risk management frameworks. This integrated approach is set out in ING’s Climate Report 2022, where the potential impacts of climate risk on other risk types – credit, market, liquidity, operational, compliance and reputational – are set out, together with a summary of the actions the bank is taking to address these. Exposures to key carbon-intensive sectors are disclosed, covering power generation, oil and gas, real estate, cement, steel, automotive, aviation and shipping, together with ING’s progress against its decarbonization targets in each sector. ING recognizes that identifying, assessing and disclosing climate and environmental risks is a developing area, and so the bank’s approach will continue to develop alongside this as data availability and quality improves, and as regulatory requirements evolve. Disclosing nature-related risks will be an area of future focus, and ING plans to use the TNFD Framework to inform this once available.

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Climate, environmental and sustainability risk management is a rapidly evolving area, and there is at present no universally accepted approach to it. Approaches depend on the size, scale and scope of financial institutions, their capacity and capability in respect of risk management and sustainability, and the focus and extent of development of relevant national and international regulatory regimes. This is an evolving area of regulatory focus that will continue to have significant impacts on financial institutions’ strategies and decision making, and on the practice of risk and finance professionals. Regulators play an important role in harmonizing and standardizing approaches, and in facilitating the development and sharing of best practice, as we will see in the following section.

The evolving regulatory response to climate, environmental and sustainability risks As we have explored in this chapter, physical, transition and liability risks impact a wide range of risks faced by all organizations, including financial institutions. Whilst acute physical risks may impose direct costs in the short term, chronic physical risks, transition risks and liability risks can affect organizations’ business models in the medium and longer terms. All will impact the lending and investment decisions, strategies and activities of banks, investors and insurers. Financial institutions exposed to sectors and firms that are highly dependent on fossil fuels are especially vulnerable to climate and environmental risks, particularly transition risks. As well as causing difficulties for individual financial institutions, they can also threaten financial stability overall. The prudential and systemic risks caused by climate, environmental and sustainability factors explain why it is in the interests of central banks and financial regulators to ensure that those risks – particularly climate-related risks at present – are identified, managed and disclosed by organizations, especially financial institutions. A coordinated, systematic approach to climate, environmental and sustainability risks is essential from a regulatory perspective to identify and assess risks to prudential and financial stability, and to help boards, investors and other decision makers compare and contrast different strategies, activities and investments. Given the global and interdependent nature of the financial services sector, a harmonized and standardized (as far as possible) approach to climate, environmental and sustainability risk management is in the interests of firms and of regulators. As we discuss in this section, a number of global regulatory bodies and policymakers, as well as national central banks and financial regulators, are therefore adopting similar approaches to the identification, management, disclosure and supervision of climate risks. Some global and national bodies are also now beginning to consider wider environmental and other sustainability risks, and we will also consider this briefly below.

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QUICK QUESTION What global/international approaches to the identification, disclosure and management of climate, environmental and sustainability risks are you aware of?

Three key global regulatory and finance sector bodies taking the lead in coordinating and harmonizing responses to climate and other environmental and sustainability risks, and examined in more detail below, are: ●●

the Financial Stability Board (FSB), which established the Task Force on Climaterelated Financial Disclosures (TCFD);

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the Network for Greening the Financial System (NGFS); and

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the Taskforce on Nature-related Financial Disclosures (TNFD).

To help inform the priorities and work programmes of the FSB and the NGFS, both bodies have recently undertaken ‘stocktakes’ (reviews) to examine how central banks and financial regulators are approaching the regulation and supervision of climate risks. Each stocktake, as we shall see below, had a different focus, but some common themes can be drawn out: ●●

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Firstly, climate risk is an emerging and evolving regulatory priority, although there are considerable discrepancies between jurisdictions at present as to the extent to which climate risk is currently embedded in regulatory and supervisory practices. Secondly, global coordination between central banks and regulators through bodies such as the FSB and NGFS is required to respond to the challenges of climate change and support the transition to net zero. Central banks and regulators need to work with a wide range of market participants, data providers, the scientific community and stakeholders if this is to be successfully achieved. Thirdly, central banks and regulators also need to begin to consider wider environmental and sustainability risks beyond climate change; this feeds into the work of the TNFD.

Financial Stability Board (FSB) The Financial Stability Board (FSB)22 comprises central banks, public international financial institutions (for example, the World Bank) and international standardsetting organizations. It has a mandate to strengthen financial systems and promote international financial stability by coordinating the development of strong regulatory, supervisory and other financial sector policies, and to encourage consistency in the implementation of these.

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The FSB has played a key role in highlighting the risks of climate change to international and national financial stability. In 2015, the FSB established a Task Force on Climate-related Financial Disclosures (TCFD) – see below – to develop recommendations for a consistent, international approach to the identification, disclosure and management of climate-related financial risks. The TCFD would, in the FSB’s view, develop climate-related disclosures that ‘could promote more informed investment, credit and insurance underwriting decisions’ which in turn ‘would enable stakeholders to understand better the concentrations of carbon-related assets in the financial sector and the financial system’s exposures to climate-related risks’. The FSB noted that disclosures by the financial sector, in particular, would ‘foster an early assessment of these risks’ and ‘facilitate market discipline’. Such disclosures would also ‘provide a source of data that can be analysed at a systemic level, to facilitate authorities’ assessments of the materiality of any risks posed by climate change to the financial sector, and the channels through which this is most likely to be transmitted’.23 Whilst the TCFD has had strong support and encouragement from many central banks and financial regulators and its recommendations are now being included within legal and regulatory disclosure requirements in some jurisdictions, compliance is still mostly voluntary, that is, encouraged, not mandated. We discuss this in more detail below. The FSB’s 2020 stocktake focused on central banks’ and regulators’ experiences of including climate risks in their financial stability monitoring. It found there was wide variance in terms of whether, and to what extent, regulators considered climate risks. The FSB’s findings included the following: ●●

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approximately three-quarters of regulators included or were planning to include climate-related risks as part of their financial stability monitoring; of those regulators that considered climate risks, most focused on their impact on asset prices and credit quality; a minority of regulators that considered climate risks also considered their implications for underwriting, legal, liability and operational risks; a minority of regulators considered how climate risks affect financial institutions and the financial system could impact the real economy.24

Whilst the results may appear surprising to those active in the field of green and sustainable finance, we should remember that climate risks (and still more so broader environmental and social sustainability risks) have only become a focus for central banks and regulators in recent years. Much of the initial work on these has been undertaken to date by a fairly small number of institutions – albeit high-profile, influential ones. Through the work of global bodies such as the FSB, and the NGFS (discussed

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below), we can expect climate and other environmental and social sustainability risks to become priorities and key parts of central banks’ and regulators’ supervisory activities in the coming years in those jurisdictions where this is not already the case.

Network for Greening the Financial System (NGFS) Recognizing the need for a wider global regulatory response to climate risk, and the need for greater global cooperation and harmonization of approaches, in December 2017 eight central banks launched the Network for Greening the Financial System (NGFS) at the Paris ‘One Planet Summit’. By 2022, the NGFS had grown to 114 members (central banks and financial regulators overseeing economies accounting for the great majority of global carbon emissions) and 18 observers, emphasizing the importance of climate risk to the global financial system and its regulators.25 The NGFS aims to share best practice between central banks and financial regulators and, in doing so, to: (a) accelerate and coordinate their work on climate and environmental risks, and (b) support the mainstreaming of green and sustainable finance. The NGFS works with a wide range of existing international and national regulatory bodies to feed into and build on their work, rather than duplicating activities already underway elsewhere. This includes working with bodies such as the Sustainable Banking Network (SBN), the Sustainable Insurance Forum (SIF), the Sustainable Finance Network (SFN) and UNEP FI, amongst others. The NGFS 2020 stocktake focused on the balance sheets and operations of central banks as financial institutions themselves, how these could be impacted by climate change and climate risks, and how this in turn could affect monetary policy. The results confirmed an increasing and shared awareness of climate risks among central banks, even if only limited, concrete actions had been taken to date. The findings included the following: ●●

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all central banks considered climate change to be a challenge because of its potential threat to the economy and its impact on central banks’ operational frameworks; the majority of central banks saw scope in their mandates to reflect climate risks; most central banks were currently at a very early stage in determining their detailed approach to the management of climate risks; the main incentive for central banks to adopt a more proactive approach to climate risks was to support an orderly economic transition to net zero; central banks see international coordination of approaches to climate risks as key.26

Although there is a general and shared understanding that climate change poses a challenge for central banks, the stocktake revealed that, in practice, many central banks were still at an early stage in considering adjustments to their operational

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frameworks to incorporate climate change-related factors. In addition, the review found that, whilst more than half of the central banks surveyed considered stranded assets to be of concern now or in the future, a substantial minority did not – which was surprising given the potential impacts of transition risks, especially on economies dependent on fossil fuel extraction and processing. This may, however, reflect the focus of the NGFS review on central banks’ own balance sheets and monetary policy; some central banks had already taken steps to improve the resilience of their balance sheets to climate risks as a result of national political and economic policy decisions. The NGFS has also developed an expanding set of guidance and tools for sharing knowledge and best practice, both to help central banks address climate risks in their own operations27 and to support and harmonize approaches to the supervision of financial institutions in respect of climate risks. In terms of the latter, the work of the NGFS to develop climate scenarios to support forward-looking climate risk assessment is particularly notable, and is described in the reading below (scenario analysis is described in more detail in the context of the TCFD below).28

READING NGFS Climate Scenarios29 The NGFS Climate Scenarios have been developed to provide a common starting point for analysing climate risks to the economy and financial system. While developed primarily for use by central banks and supervisors, they may also be useful to the broader financial, academic and corporate communities. Initially (September 2020), eight scenarios were developed, based on three representative scenarios: ●●

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Orderly: Early, ambitious action to support a net zero CO2 emissions economy. Climate policies were introduced early and gradually became more stringent. Net zero CO2 emissions were achieved before 2070, giving a 67 per cent chance of limiting global warming to below 2°C. Physical and transition risks were both relatively low. Disorderly: Action that is late, disruptive and sudden. This representative scenario assumed climate policies were not introduced until 2030, requiring emissions reductions to be more rapid than in the Orderly scenario to limit global warming. This resulted in higher transition risks. Hot House World: Limited climate action leads to a hot house world with significant global warming and, as a result, strongly increased exposure

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to physical risks. This representative scenario assumed that only currently implemented climate policies were continued. Countries’ NDCs were not met. Emissions grow until 2080, leading to 3°C+ of warming and severe physical risks; the impacts of these resulted in a loss in GDP of up to 25 per cent by 2100. The NGFS update scenarios annually to reflect developments in climate science, our understanding of the impacts of climate change and countries’ commitments to climate action. Six updated scenarios were published in 2021, and these were further updated in 2022 to reflect countries’ more ambitious NDCs, and with more sectoral detail and an enhanced appreciation of the impacts of physical risks. The current (2022) NGFS scenarios are: Orderly ●● Net Zero 2050: an ambitious scenario that limits global warming to 1.5°C through stringent climate policies and innovation, reaching net zero CO2 emissions around 2050. Physical risks are low and transition risks are high. ●●

Below 2°C: gradually increases the stringency of climate policies, giving a 67 per cent chance of limiting global warming to below 2°C. Physical and transition risks are relatively moderate (compared with other scenarios).

Disorderly ●● Divergent Net Zero: reaches net zero around 2050 but with higher costs due to divergent policies and carbon pricing introduced across sectors, leading to a quicker phase out of oil use. Transition risks are relatively high, therefore. ●●

Delayed Transition: global annual emissions do not decrease until 2030, and rapid climate action is then needed to limit global warming to below 2°C. This leads to higher physical and transition risks.

Hot House World ●● Nationally Determined Contributions: assumes that current pledged levels of climate action continue, so emissions decline, but only to limit warming to around 2.6°C. Physical risks are increased but transition risks are relatively low. ●●

Current Policies: only current climate action policies are implemented. Emissions continue to increase, leading to more than 3°C of global warming and significant physical risks.

NGFS scenarios are supported by an interactive portal (https://www.ngfs.net/ngfsscenarios-portal/) that allows users to explore different aspects of the scenarios and the physical and transition risks associated with these.

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QUICK QUESTION Visit the NGFS climate scenario portal at https://www.ngfs.net/ngfs-scenariosportal/explore. How do the impacts of physical and transition risks manifest under different scenarios?

Task Force on Climate-related Financial Disclosures (TCFD) The Task Force on Climate-related Financial Disclosures (TCFD) was established by the FSB in December 2015, under the chairmanship of Michael Bloomberg, and comprised 32 members drawn from across the finance sector. The TCFD’s remit was to develop voluntary, climate-related financial risk (physical, liability and transition risk) disclosures for use by companies providing information to investors, lenders, insurers and other stakeholders, to bring consistency to effective disclosures across industry sectors. By encouraging and promoting greater, more consistent disclosure, climate-related financial risks should become more central to board and investor decision making, as well as to shareholder engagement with management on climate change issues. In June 2017, the TCFD published its Recommendations of the Task Force on Climate-related Financial Disclosures, which sets out proposals for consistent, climate-related financial risk disclosures by organizations.30 These are intended to be relevant to preparers and users of financial information in all industry sectors, although the TCFD stresses that financial services firms such as banks, insurers and asset managers have a particularly important role to play in influencing the organizations in which they invest in order to provide more robust, consistent and comparable climate-related financial disclosures. The TCFD notes that climate change may affect all parts of an organization’s financial performance, including, but not limited to, capital, financing, revenue, expenditure, assets and liabilities. In the TCFD’s view, climate-related financial risks are or could be material for many organizations and will likely become more so in the future, and it recommends that organizations disclose these risks in their annual and other statutory, public reports. Importantly, the TCFD’s framework for disclosures is intended to be incorporated within existing disclosures, rather than imposing an additional burden on reporting firms – and to ensure that they are not separate from key financial and other information reported to investors and others.

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TCFD: Recommended disclosures The TCFD sets out four key ‘thematic areas’ that, in its view, represent core elements of how organizations operate. It recommends that organizations report their approach to identifying and managing climate-related financial risks against these: 1 Governance: the organization’s governance around climate-related risks and opportunities. 2 Strategy: the actual and potential impacts of climate-related risks and opportunities on the organization’s businesses, strategy and financial planning. 3 Risk management: how the organization identifies, assesses and manages climaterelated risks. 4 Metrics and targets: used to assess and manage relevant climate-related risks and opportunities.31 The TCFD also proposes Recommended Disclosures for each, as set out in Table 5.3. In addition, for the financial services sector and for four key non-financial sectors (energy; transport; buildings and materials; agriculture, food and forestry), the TCFD has developed supplemental guidance to highlight important sector-specific considerations and provide a fuller picture of potential climate-related financial impacts in those sectors.32 The TCFD’s proposals have been strongly supported and endorsed by national and international regulators and policymakers, leading to their implementation by many financial institutions and publicly listed companies. As of January 2022, more than 3,400 organizations from 95 countries had expressed their support for and agreed to voluntarily align their disclosures with the TCFD’s recommendations. Some have criticized the voluntary nature of the TCFD (and other disclosure initiatives) because, despite the rapid growth in the number of companies supporting the TCFD and adopting its recommended disclosures, they represent only a small minority of organizations globally. In addition, many organizations that do adopt the TCFD recommendations are not necessarily able to report metrics and targets in detail. This is a particular issue for financial institutions, given the challenges we saw in the previous chapter in measuring Scope 3 (financed) emissions in lending and investment portfolios, although, as we also saw, new tools and frameworks are emerging which should assist with measuring and reporting. Since the launch of the TCFD in 2017, UNEP FI has convened groups of banks, insurers and investors to pilot approaches to implementing the TCFD’s recommendations in the finance sector. As well as developing and sharing good practice in identifying, measuring and disclosing climate risks, UNEP FI and participating organizations have developed a wide range of guidance, frameworks and tools to help financial institutions implement TCFD reporting. These are available at https://www. unepfi.org/climate-change/tcfd/.

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Table 5.3  TCFD thematic areas and recommended disclosures TCFD thematic areas

TCFD recommended disclosures

1. Governance

Describe the board’s oversight of climate-related risks and opportunities Describe management’s role in assessing and managing climate-related risks and opportunities

2. Strategy

Describe the climate-related risks and opportunities the organization has identified over the short, medium, and long term Describe the impact of climate-related risks and opportunities on the organization’s businesses, strategy and financial planning Describe the resilience of the organization’s strategy, taking into consideration different climate-related scenarios, including a 2°C or lower scenario

3. Risk management

Describe the organization’s processes for identifying and assessing climate-related risks Describe the organization’s processes for managing climaterelated risks Describe how processes for identifying, assessing and managing climate-related risks are integrated into the organization’s overall risk management

4. Metrics and targets

Disclose the metrics used by the organization to assess climaterelated risks and opportunities in line with its strategy and risk management process Disclose Scope 1, Scope 2, and, if appropriate, Scope 3 greenhouse gas (GHG) emissions, and the related risks Describe the targets used by the organization to manage climate-related risks and opportunities and performance against targets

SOURCE  TCFD (2017) Recommendations of the Task Force on Climate-related Financial Disclosures, https://assets. bbhub.io/company/sites/60/2020/10/FINAL-2017-TCFD-Report-11052018.pdf

TCFD reporting is also becoming mandatory in an increasing number of jurisdictions. This should increase its coverage and accelerate efforts to improve measuring and reporting. For example: ●●

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In 2020, New Zealand became the first country to announce that it would require TCFD-aligned disclosures from its financial sector (on a ‘comply or explain’ basis), from 2023. Later that same year, the UK announced a commitment to become the first country in the world to make TCFD-aligned disclosures mandatory for all large companies from 2022, going beyond the ‘comply or explain’ approach.

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Other G7 and developed economies, including Canada, France, Japan, Switzerland and Singapore, will require TCFD reporting for financial institutions and/or larger companies. At the European level, the Non-Financial Reporting Directive, which sets out minimum requirements for climate-related and other environmental risk disclosures for more than 6,000 European companies, has been updated to align with the TCFD’s recommendations.

At the sector level, beginning in 2020 signatories to the Principles for Responsible Investment (PRI) were expected to disclose climate-related risks in line with the TCFD recommendations.33

QUICK QUESTION Is TCFD-aligned reporting required (or will it be required) where you live and work? If so, to which categories of organizations will it apply? A further criticism of the TCFD is that it is an initiative to improve and promote the process of disclosure, rather than necessarily the quality of those disclosures themselves. Publishing details of an organization’s approach to governance, strategy and risk management does not by itself ensure that decision makers, investors, regulators and others will have access to the information required to assess organizations’ exposure to climate risks. This requires accurate, verifiable and timely climate and environmental datasets (e.g. emissions, air and water pollution, temperature, water levels and crop production) which, until relatively recently, were difficult and ­expensive to obtain, as we discussed in Chapter 4. By encouraging, enhancing and requiring disclosures of climate and other sustainability risks facing organizations, central banks, regulators and initiatives such as the TCFD should increase the quantity and quality (the credibility, consistency and comparability) of publicly available data. In turn, this should improve risk management and decision making by boards, investors, lenders and others. In the previous chapter, we explored how financial institutions are adopting data-driven approaches and tools, including PCAF, the Science-Based Targets and PACTA, to bring greater consistency and comparability to the measuring and reporting of greenhouse gas emissions financed by financial institutions. This helps institutions assess and manage their exposure to climate risks, particularly transition risks.

TCFD: Scenario analysis As we have seen in earlier chapters, it is difficult to understand and measure climate and environmental sustainability risks due to the complexity and interrelated nature

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of the variables and feedback loops involved. It is also challenging to estimate the future financial impacts of climate and environmental risks, as they depend on different scenarios and assumptions regarding the degree and speed of global warming, the speed and scope of energy and economic transitions, changing policy and regulation, and many other variables. These in turn impact global temperatures and other environmental factors. Despite this, policymakers, regulators, financial institutions and others need to try to model the future impacts of climate and environmental risks to develop appropriate climate change mitigation and adaptation policies and interventions, as well as business and financial strategies and approaches for banks, insurers, investors and their clients and customers. This involves developing climate scenarios, defined by the IPCC as ‘a plausible representation of future climate that has been constructed for explicit use in investigating the potential impacts of anthropogenic climate change’.34 In turn, climate scenarios can be used as the basis for scenario analysis – a well-established method used by organizations for developing strategic plans that consider a range of possible future states. In terms of trying to understand climate risks, scenario analysis is used to try to understand the impact of different assumptions regarding the speed and impacts of climate change and other factors on economic activities and entities, on organizations and on financial institutions’ lending and investment portfolios. This helps identify both the risks faced and the opportunities that can be seized by financial institutions. Scenario analysis is not intended to produce accurate and detailed forecasts of the future, particularly in the longer term, but to provide insight into a potential range of outcomes that can help firms, regulators and investors with their strategic planning, asset allocation, risk management and other decisions, as exemplified in Royal Dutch Shell’s ‘Sky Scenario’, briefly described in the following case study.

CASE STUDY Shell’s Sky Scenario35 Royal Dutch Shell was a pioneer in the use of scenario analysis to develop its business strategy in the 1960s and 1970s. More recently, it has used scenario analysis to explore the potential impacts of a range of climate change scenarios on its strategy and future business. Shell’s ‘Sky Scenario’ illustrates a challenging, but technically possible, way for society as a whole (not only Shell itself) to achieve net zero. Essential to this outcome are seven key and mutually reinforcing drivers: From now to 2070: 1 A change in consumer mindset means that people preferentially choose lowcarbon, high-efficiency options to meet their energy service needs. 2 A step-change in the efficiency of energy use leads to gains above historical trends.

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3 Carbon-pricing mechanisms are adopted by governments globally over the 2020s, leading to a meaningful cost of CO2 embedded within consumer goods and services. 4 The rate of electrification of final energy more than triples, with global electricity generation reaching a level nearly five times today’s level. 5 New energy sources grow up to 50-fold, with primary energy from renewables eclipsing fossil fuels in the 2050s. 6 Some 10,000 large carbon-capture and storage facilities are built, compared to fewer than 50 in operation in 2020. 7 Net zero deforestation is achieved. In addition, an area the size of Brazil being reforested offers the possibility of limiting warming to 1.5°C, the ultimate ambition of the Paris Agreement.

The use of scenario analysis is strongly encouraged by the TCFD, with one of its key recommended disclosures focusing on the resilience of an organization’s strategy, taking into consideration different climate-related scenarios, including a 2°C or lower scenario. To help organizations use scenario analysis to model the impact of climate risks, the TCFD has published guidance for organizations: The Use of Scenario Analysis in Disclosure of Climate-related Risks and Opportunities36 (from which the reading below is taken) and Guidance on Scenario Analysis for Non-Financial Companies.37 As we saw above, the NGFS and other central banks have published climate scenarios for use by financial institutions. UNEP FI has also published a range of resources to help financial institutions apply scenario analysis, including Pathways to Paris: A practical guide to climate transition scenarios for financial professionals.38

READING TCFD guidance on scenario analysis39 The purpose of scenario analysis is to consider and better understand how a business might perform under different future states (i.e. its resiliency/robustness). In the case of climate change, climate-related scenarios allow an organization to develop an understanding of how the physical and transition risks and opportunities of climate change might plausibly impact the business over time. Scenario analysis, therefore, evaluates a range of hypothetical outcomes by considering a variety of alternative plausible future states (scenarios) under a given set of assumptions and constraints.

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A critical aspect of scenario analysis is the selection of a set of scenarios that cover a reasonable variety of future outcomes, both favourable and unfavourable. While there is an almost infinite number of possible scenarios, organizations can use a limited number of them to provide the desired variety. In this regard, the Task Force is recommending that organizations use, at a minimum, a 2°C scenario, and consider using other scenarios that are most relevant to the organization’s circumstances, such as scenarios related to Nationally Determined Contributions (NDCs), businessas-usual (greater than 2°C) scenarios, physical climate risk scenarios or other challenging scenarios. Applying scenario analysis, although potentially complex, has a number of significant benefits for organizations faced with the uncertainties of climate change. For organizations just beginning to use scenario analysis, a qualitative approach may be appropriate. As organizations gain experience with scenario analysis, and for organizations already conducting scenario analysis, greater rigour and sophistication in the use of data sets and quantitative models and analysis may be warranted. Quantitative approaches may be achieved by using existing external scenarios and models (for example, those provided by third-party providers), or by organizations developing their own, in-house modelling capabilities. The choice of approach will depend on an organization’s needs, resources and capabilities. Organizations that are likely to be significantly impacted by climaterelated transition and/or physical risks should consider some level of quantitative scenario analysis. As a starting point, the Task Force recommends using relevant scenarios developed by the International Energy Agency (IEA) and the Intergovernmental Panel on Climate Change (IPCC). The IEA has developed six different transition scenarios, which are reproduced by the TCFD. Also included are a number of 2°C scenarios and tools developed by the International Renewable Energy Agency (IRENA), REmap, Greenpeace, the Advanced Energy Revolution and the Deep Decarbonization Pathways Project (DDPP). To help firms develop accurate and useful climate scenarios, the IPCC has set in place five criteria which should be followed: 1 Consistency with global projections The scenarios should be consistent with a broad range of global warming projections based on increased concentrations of greenhouse gases. This range is variously cited as 1.4°C to 5.8°C by 2100, or 1.5°C to 4.5°C for a doubling of atmospheric CO2 concentration (otherwise known as ‘equilibrium climate sensitivity’).

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2 Physical plausibility The scenarios should be physically plausible; that is, they should not violate the basic laws of physics. Hence, changes in one region should be physically consistent with those in another region, and globally. In addition, the combination of changes in different variables (which are often correlated with each other) should be physically consistent. 3 Applicability in impact assessments The scenarios should describe changes in a sufficient number of variables on a spatial and temporal scale that allows for impact assessment. For example, impact models may require input data on variables such as precipitation, solar radiation, temperature, humidity and windspeed at spatial scales ranging from global to site and at temporal scales ranging from annual means to daily or hourly values. 4 Representative The scenarios should be representative of the potential range of future regional climate change. Only in this way can a realistic range of possible impacts be estimated. 5 Accessibility The scenarios should be straightforward to obtain, interpret and apply for impact assessment. Many impact assessment projects include a separate scenario development component which specifically aims to address this last point. The DDC and this guidance document are also designed to help meet this need. Considerations for building climate change into scenario analysis Recognizing the benefits of scenario analysis and the need to minimize implementation costs, organizations undertaking scenario analysis for the first time may want to consider starting with a simple yet robust process for incorporating climate-related considerations into their scenarios. First, an organization needs to understand the nature of the climate-related risks and opportunities it may face. Each individual organization faces a different blend of climate-related risks and opportunities. The business impacts related to climate change may vary significantly depending on the industry and economic sector(s)/ sub-sector(s) in which an organization operates. Business impacts may also vary significantly, depending on: ●●

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the geographic location of the organization’s value chain (both upstream and downstream); the organization’s assets and nature of operations;

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●● ●● ●●

the structure and dynamics of the organization’s supply and demand markets; the organization’s customers; and the organization’s other key stakeholders.

Many organizations already disclose their views on climate-related risks and opportunities at a high, qualitative level. The Task Force’s Phase I report identified several frameworks for reporting climate-related information, many of which include disclosures concerning risks and opportunities. Such information provides a starting point for scenario analysis and for further disclosure. Organizations should carefully consider the key parameters, assumptions and other analytical choices they make during scenario analysis, as well as the potential impacts or effects that are identified and how those results are considered by management. They should consider disclosing this information, where appropriate. In particular, organizations are encouraged to disclose the approach used for selecting scenarios, as well as the underlying assumptions for each scenario regarding how a particular pathway might develop (for example, the emergence and deployment of key technologies, policy developments and timing, the geopolitical environment around climate policies). It is important for an organization to disclose and discuss information that includes the sensitivity of various assumptions to changes in key parameters such as carbon prices, input prices, customer preferences, etc., so that investors and other stakeholders have a clear understanding of the scenario process – not just the outcomes each scenario describes, but the pathway envisioned by the organization that leads to that outcome. Transparency concerning key parameters, assumptions and analytical choices will help support comparability of the results of the different scenarios used by an organization and across organizations. In turn, this will support evaluation by analysts and investors of the potential magnitude and timing of impacts on individual organizations and sectors, and the robustness of organizations’ strategies across the range of plausible impacts, thereby supporting better risk and capital allocation decisions. Given the number of variables and analytical approaches to scenario analysis, there will be a wide range of scenarios used that describe various outcomes. Given this, direct comparability across organizations is likely to be a very real challenge. This underpins the importance of transparency across the three categories of considerations. Keeping in mind that improved disclosure and transparency are important for comparability, organizations should consider disclosing as many of these considerations as possible and endeavour to increase their levels of disclosure over time.

Figure 5.2  A process for applying scenario analysis to climate-related risks and opportunities

1 2

Ensure governance Integrate scenario analysis into strategic planning and/or enterprise risk management frameworks. Assign oversight to relevant board committees/ sub-committees. Identify which internal (and external) stakeholders to involve, and how.

Assess materiality of climate-related risks

Market and technology shifts

Reputation

Policy and legal

Physical risks

What are the current and anticipated organizational exposures to climaterelated risks and opportunities? Do these have the potential to be material in the future? Are organizational stakeholders concerned?

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3

Identify and define range of scenarios

Transition risk scenarios

Physical risk scenarios

What scenarios (and narratives) are appropriate, given the exposures? Consider input parameters, assumptions and analytical choices. What reference scenario(s) should be used?

4

Evaluate business impacts

5

Identify potential responses

Impact on:

Responses might include:

– – – – – –

– Changes to business model – Portfolio mix – Investments in capabilities and technologies

Input costs Operating costs Revenues Supply chain Business interruption Timing

Evaluate the potential effects on the organization’s strategic and financial position under each of the defined scenarios. Identify key sensitivities.

Use the results to identify applicable, realistic decisions to manage the identified risks and opportunities. What adjustments to strategic/financial plans would be needed?

Document and disclose Document the process; communicate to relevant parties; be prepared to disclose key inputs, assumptions, analytical methods, outputs and potential management responses.

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For investors and lenders, scenario analysis may be applied in different ways, depending on the nature of the asset(s) being considered. For example, some investors may develop energy transition pathways that they believe to be either optimal and/or likely and use them to model the expected return on investment under different scenarios. Investors and lenders with different time horizons may focus on different areas in their scenario analysis. Those with shorter-term horizons may place more weight on short-term physical risks that may (in some cases) be easier to forecast with greater accuracy; those with longer-term horizons may be more interested in longer-term transition risks and the development and implementation of climate policies such as carbon pricing and taxes. Other investors and lenders may consider how climate-related scenarios relate to the future performance of particular sectors, regions or asset classes. The results may show that some portions of a portfolio are set to benefit from a particular scenario, whilst others face losses. Such results, while not conclusive, can be a useful additional factor in determining where to prioritize further risk management activities. These findings could also be useful when making decisions relating to asset allocation, diversification and the decarbonization of lending and investment portfolios. Given that firms, investors and others may choose – for sound reasons – different assumptions and different climate-related scenarios, and focus on different aspects of these, it can be difficult to compare results. Central banks and other regulators, therefore, are beginning to standardize their approaches when publishing climate scenarios. The NGFS Climate Scenarios, published in 2020 and updated in 2021, were described above. Three of the NGFS scenarios were used by the Bank of England as a basis for its 2021 ‘Climate Biennial Exploratory Scenario’ exercise, designed to explore the financial risks posed by climate change to the largest UK banks and insurers; we examine this in the case study below.40

CASE STUDY Bank of England 2021 Climate Biennial Exploratory Scenario41 In 2021, the Bank of England conducted an exploratory stress-testing exercise for major UK banks, building societies and insurers using three climate scenarios, based on a subset of scenarios developed by the Network for Greening the Financial System. These were: ●●

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Early action – where ambitious and early climate action limits global warming to 1.8°C in 2050, falling to 1.5°C by the end of the century. Late action – where policy measures are delayed and a more drastic, disorderly transition results, but global warming is still limited to 1.8°C in 2050 and remains at this level to the end of the century.

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No additional action – a deliberately severe scenario characterized by major physical risks where the lack of policy action means global warming rises to 3.3°C by 2050.

The main aims of the exercise were to assess the climate risks facing major UK financial institutions (including both their UK and international activities), to help them better understand their vulnerabilities to physical and transition risks, to improve the identification and management of these and to evaluate the financial exposures of institutions and the financial system overall to climate change. Key findings from the Exploratory Scenario exercise included: ●●

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UK banks and insurers were making good progress in some aspects of their climate risk management, but still needed to do much more to understand and manage their exposure to climate risks. The lack of available data on companies’ current emissions and future transition plans was a collective issue affecting all participating firms. Climate risks will hit the profitability of banks and insurers, particularly if they are unable to manage these risks effectively. There is substantial uncertainty about the true magnitude of these risks, however, and some risks were not captured by this exercise. Bank credit losses rise under all the scenarios, with the most carbon-intensive sectors generating the highest credit losses. The greatest credit losses occur under the Late Action scenario, estimated at a total of approximately £225 billion by 2050. Losses are highest on banks’ wholesale and mortgage lending portfolios. Around 20 per cent of banks’ most significant corporate exposures are to counterparties to which another bank also has a lending exposure. There are, therefore, some systemic concerns arising from this. Insurers’ asset values suffer the greatest losses (15 per cent) in the No Additional Action scenario, compared with 8 per cent and 11 per cent losses in the Early and Late Action scenarios. Losses result from falls in the value of equity holdings, increases in credit downgrades and more defaults in insurers’ corporate bond portfolios. The transition to net zero materially impacts carbon-intensive sectors, and it is in banks’ and insurers’ collective interests to both support the transition of companies and gradually reduce exposures in these sectors. All participating banks and insurers have published climate strategies or netzero transition plans that include reducing support to the most carbon-intensive sectors and engaging with organizations to facilitate their transitions to net zero business models. The collective impact of such plans could have negative consequences for the wider economy, however.

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●●

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Some financial institutions, responding to the No Additional Action scenario in particular, noted there could be material reductions in lending to and insurance for households and firms most exposed to physical risks. Banks and insurers reported that they would be better able to prepare and plan for the transition if the evolution of climate policy was clear and well communicated.

Taskforce on Nature-related Financial Disclosures (TNFD) In Chapter 2, we saw that biodiversity is declining at a rate unprecedented in human history. Wildlife populations have fallen by 60 per cent since 1970, and some 1  million animal and plant species are threatened with extinction, including more than 40  per  cent of amphibians, more than 33 per cent of marine mammals and almost 33 per cent of reef-forming corals.42 Since the beginning of human civilization, according to the UNEP and others, 50 per cent of the world’s forests and 70 per cent of the world’s wetlands have been lost.43 The Dasgupta Review (2021) found that human demands significantly exceed nature’s capacity to supply us with the goods and services we rely on to maintain our current standard of living and, as nature is harmed or destroyed, its capacity to support a growing human population at current levels continues to decline.44 Finance is both dependent on and impacted by nature and biodiversity. In 2020, for example, De Nederlandsche Bank (the Dutch central bank) reported that Dutch banks, insurance companies and pension funds were exposed to approximately €510  billion of lending and investment in companies reliant on biodiversity and nature.45 In the same year, the World Economic Forum (WEF) found that some $44  trillion – more than half of the world’s GDP – was moderately or highly dependent on nature, and therefore at risk from losses in biodiversity and other nature-related factors.46

QUICK QUESTION Think of some of the products and services produced by a company you are familiar with. Which are highly dependent on biodiversity and nature? How might these be impacted by further biodiversity loss?

Risk management

Financial institutions therefore face substantial financial risks from the loss of biodiversity and other environmental harms and, as with climate risks, these are cross-cutting risks that impact on many other risk types and can also compound the impacts of climate change. Banks, insurers and investors can also seek opportunities from developing and supporting nature-based solutions to climate change and other societal issues, however, with what the WEF terms a ‘new nature economy’ estimated to generate over $10 trillion in annual business value and creating 395 million jobs by 2030.47 A growing appreciation of these nature-based risks and opportunities, as well as an understanding of the interdependencies and feedback loops between biodiversity, the natural world and climate change, prompted the establishment of a Taskforce on Nature-related Financial Disclosures (TNFD) in 2021. Founding members included governments, international organizations and NGOs, including the United Nations Development Programme (UNDP), the United Nations Environment Programme Finance Initiative (UNEP FI) and the World Wide Fund for Nature (WWF). As of May 2022, more than 400 financial institutions and other companies and NGOs have joined the TNFD Forum to contribute to its work.48 Building on the approach of the TCFD, the TNFD aims to develop similar, TCFDstyle recommendations that can be adopted by organizations to help them identify, disclose and manage nature-related risks (as well as identify and take advantage of opportunities), and to steer finance towards outcomes that are nature-positive, in alignment with the Paris Agreement, the UN Sustainable Development Goals and the Convention on Biological Diversity Post-2020 Global Biodiversity Targets. A beta (draft) version of the TNFD’s framework was published in March 2022 for feedback from users and stakeholders,49 with the intention being to publish a final version in late 2023 – Green and Sustainable Finance Professionals are recommended to follow the work of the TNFD as it develops. The TNFD’s draft disclosure recommendations for nature-based risks and opportunities follow the TCFD’s four key thematic areas: governance, strategy, risk management, and metrics and targets, as set out in Table 5.4. By aligning the TNFD’s recommended disclosures closely with those of the TCFD, the TNFD aims to encourage more integrated disclosures that include both climate-related and nature-related risks.

National regulatory responses to climate, environmental and sustainability risks As we discussed above, climate and environmental risks have become emerging priorities for central banks and financial regulators in recent years, and seem set to remain so. There is substantial global cooperation through bodies including the FSB and NGFS, and increasing harmonization and standardization of approaches,

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Table 5.4  TNFD thematic areas and recommended disclosures (draft) TNFD thematic areas

TCFD recommended disclosures

1. Governance

Describe the board’s oversight of nature-related risks and opportunities Describe management’s role in assessing and managing naturerelated risks and opportunities

2. Strategy

Describe the nature-related risks and opportunities the organization has identified over the short, medium, and long term Describe the impact of nature-related risks and opportunities on the organization’s businesses, strategy, and financial planning Describe the resilience of the organization’s strategy, taking into consideration different scenarios Describe the organization’s interactions with low-integrity ecosystems, high-importance ecosystems or areas of water stress

3. Risk management

Describe the organization’s processes for identifying and assessing nature-related risks Describe the organization’s processes for managing nature-related risks Describe how processes for identifying, assessing, and managing nature-related risks are integrated into the organization’s overall risk management

4. Metrics and targets

Disclose the metrics used by the organization to assess and manage nature-related risks and opportunities in line with its strategy and risk management process Disclose Scope 1, Scope 2, and, if appropriate, Scope 3 greenhouse gas (GHG) emissions, and the related risks – adoption under consideration by the TNFD Describe the targets used by the organization to manage naturerelated risks and opportunities and performance against targets

SOURCE  TNFD (nd) Disclosure Recommendations, https://tnfd.global/wp-content/uploads/2022/03/DisclosureRecommendations.pdf

especially on disclosures through the TCFD and, more recently, the TNFD. For most financial institutions, and finance and risk professionals, whilst the global picture is helpful in setting the broad direction of travel and informing organizations’ strategies and planning, it is the priorities, supervisory activities and reporting requirements of national central banks and regulators that have the most direct impacts on professional practice. There is not the space within the confines of this book to explore in any detail the different and often rapidly emerging national regulatory approaches to climate and environmental risks. In broad terms, however, there are some examples from major

Risk management

financial centres that finance and risk professionals may want to look to (and should be aware of), as other central banks and regulators often consider and draw on these when determining their own approaches. These include: ●●

●●

●●

●●

●●

The European Union – especially the European Central Bank (discussed in Chapter 8), the European Insurance and Occupational Pensions Authority, the European Securities and Markets Authority (examined in Chapter 9) and the European Banking Authority (EBA). In 2022, the EBA introduced 10 new climate risk metrics (‘Pillar 3 Disclosures on ESG Risks’) to help regulators, investors and others assess banks’ climate risks. The new reporting requirements are grouped into three categories: physical risks, transition risks and climate mitigating actions financed by a bank. The last category includes the Green Asset Ratio (GAR), which measures the extent to which a bank’s assets support sustainable economic activities as defined in the EU Taxonomy.50 The United States – following the election of President Biden in November 2020, US regulators have begun to prioritize climate, environmental and sustainability risks. The US Federal Reserve (the central bank), for example, has established a Financial Stability Climate Committee (FSCC) to identify, assess and address climate risks, and has joined the Network for Greening the Financial System. Several US regulators have published rules on climate risk disclosures, including the Office of the Comptroller of the Currency (OCC, which regulates large banks) and the Securities and Exchange Commission (SEC). The SEC’s draft Climate Disclosure Rule would require US public (listed) companies to publish their approach to and impacts of material climate-related financial risks, broadly aligned with the TCFD’s recommendations.51 China – the People’s Bank of China (the central bank) has announced plans to require commercial banks to publicly disclose information on climate risk exposures, followed by publicly listed companies, although the timeframe for the introduction of these new requirements is unclear (as of April 2022).52 Singapore – the Monetary Authority of Singapore (MAS) has published wideranging guidelines for financial institutions setting out the MAS’s supervisory expectations for banks, insurers and asset managers in their governance, risk management and disclosure of environmental risks.53 United Kingdom – as noted above, the UK is making TCFD-aligned disclosures mandatory for all large companies (listed companies, or those with more than 500 employees) from 2022. The Bank of England, the Prudential Regulation Authority (PRA) and the Financial Conduct Authority have had addressing climate change added to their mandates. They established a Climate Financial Risk Forum (CFRF) in 2019 to build capacity, develop guidance and share best practice across the regulatory community and the finance sector.54

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There is increasing convergence at the national level around key areas of regulation relating to climate risks (and, to an extent, broader environmental risks, too). This is not surprising given the global, coordinating roles played by bodies including the FSB and NGFS, discussed above. Key areas of regulatory convergence include: ●●

climate risk disclosures (aligned with the TCFD’s recommendations);

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scenario analysis and stress-testing;

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enhancing risk governance, strategy and management relating to climate risks;

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improving data availability and quality, and identifying key data sources and metrics that can help measure and monitor risks; harmonizing global carbon accounting and sustainability standards.

This last item is particularly important in the context of promoting regulatory convergence, as it supports a consistent approach towards climate risk disclosures, scenario analysis, stress testing and the successful management of climate risks overall. We discussed the harmonization of carbon accounting and other sustainability standards in the previous chapter, in particular the establishment of the new International Sustainability Standards Board by the IFRS Foundation. There are also, however, some areas of regulatory divergence. Firstly, in some countries and regions climate change and climate risks are not considered as political priorities, at least in the short and medium terms. This is the case, for example, in some countries highly reliant on fossil fuel extraction and power generation. Secondly, definitions of what authorities in different countries consider ‘green’ and ‘sustainable’ vary; there is no global taxonomy for this, rather a number of national and/or regional taxonomies, with more in development. As we saw in earlier chapters, however, the EU taxonomy may emerge as a model around which many, although not all, countries will converge. A third area of divergence relates to capital requirements. Whilst at present central banks and regulators have not included specific capital requirements to reflect climate risks, should these be introduced in the future it seems likely that the Pillar 1 (regulatory capital) and/or Pillar II (economic capital) risk weights applied at the global level could differ at the regional level. We can see this in the current Basel II/ III requirements, where risk weights and capital requirements vary between countries and regions (such as the US and UK) because of the different risks faced by financial institutions in different parts of the world. Finally, a key area of divergence is that of setting carbon prices and taxes, which vary widely at present – we will examine these in the following section.

Risk management

Pricing climate-related and environmental risks – putting a price on carbon After a series of major natural disasters in the 1990s and 2000s, the insurance sector has since led the way in identifying and pricing climate-related risks. This has focused on the physical risks of climate change, and broader environmental risks, because of the costs incurred by insurers as a result of extreme weather events such as droughts, floods, hurricanes and tropical storms. As we will see in Chapter 10, which examines the insurance sector in detail, recent years have seen economic and insured losses much higher, on average, than in previous years, with the frequency, severity and costs of extreme weather events increasing as a consequence of global warming. As we saw in Chapter 2, global warming will continue to increase the impacts of extreme weather events in the coming years. This is and will continue to be costly both to insurers and to those who need insurance – including households and businesses. Understanding the impacts of climate change, therefore, is critical for the insurance sector so that it can model expected losses, hold adequate capital against these and price risks (and the costs of insurance premiums) accurately. Until recently, the banking, asset management and investment sectors have lagged behind insurance in pricing climate and environmental risks. This is not surprising given the absence (until recently) of consistent approaches for identifying, measuring and disclosing those risks, and especially the lack of analysis of the true, long-term costs of investing in fossil fuels and other carbon-intensive assets (such as the ‘carbon bubble’, as discussed in Chapter 2). A more consistent approach prompted by central banks, regulators and the TCFD and TNFD to the disclosure of climate and environmental risks, supported by more accessible, higher-quality data, should in time lead to an increase in demand for lower-carbon alternatives more resilient to such risks. Whilst improving disclosure of climate and environmental risks is a necessary and extremely important step, it will not in itself result in a dramatic decarbonization of lending and investment portfolios, or in the whole-economy transition required to achieve the objectives of the Paris Agreement. For this to occur, households, firms and financial institutions need to be strongly incentivized to reduce their carbon use and invest in and use alternatives. Whilst this can be achieved in part through government subsidies and other incentives, supporting the whole-economy transition requires the cost of carbon – emitted in greenhouse gases such as CO2 and currently (as we saw in Chapter 1) viewed and treated by many as an externality – to be assigned an economic value. By assigning an economic value to carbon (usually per tonne), the externality is given a price (value), and economic incentives are created for households, firms and society as a whole to reduce carbon use and invest in alternatives. Pricing carbon enables more accurate pricing of climate and environmental risks, as a quantifiable

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cost of greenhouse gas emissions can be included in risk and decision-making models, including scenario analysis. This should lead to write-downs in the value of highcarbon assets, and premiums for low-carbon alternatives, as the true costs of carbon are ‘priced in’. As we will see below, however, there is no global carbon price at present, and in many jurisdictions where a carbon price has been set it is too low to incentivize decarbonization of the economy at the pace required to achieve net zero by mid-century. There are three main approaches to carbon pricing: ●●

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Carbon taxes set a price on carbon by levying a tax on the CO2 and other greenhouse gas emissions required to produce products and services, i.e. they price the externality. Although not strictly speaking carbon taxes, other energy taxes, for example those on petrol and diesel fuel, have similar objectives. According to the Centre for Climate and Energy Solutions (C2ES), 35 countries had introduced carbon taxes as of 2021.55 They include India, Japan, Denmark, Norway, Finland, France and South Africa. Australia introduced a carbon tax in 2012, but it was repealed in 2014. Emissions trading schemes (ETS) – where organizations (generally large firms and/ or the major emitters of greenhouse gases) purchase permits – often referred to as ‘carbon credits’ – that allow them to emit greenhouse gases. The cap on emissions usually becomes more onerous over time; organizations can buy and sell (trade) permits, meaning that those firms able to cut emissions and carbon usage can sell permits to others. The market, through the demand and supply for permits, sets the carbon price. Carbon offsetting – defined by the Voluntary Carbon Markets Integrity Initiative (see below) as ‘compensating or cancelling out all, or a portion of, the greenhouse gas emissions released to the atmosphere through investments in activities that reduce or remove an equivalent amount of emissions’.56 This is achieved by purchasing carbon offsets (strictly, ‘carbon offset credits’) – transferrable instruments, ideally certified by a credible verification organization, that represent reductions in emissions of CO2e. Offsets may be purchased by individuals and organizations from a wide range of providers and markets for a wide range of purposes, from offsetting the emissions from an international flight to compensating for emissions released during a carbon-intensive production process.

Emissions trading schemes Probably the best-known example of an emissions trading scheme is the EU Emissions Trading System (EU ETS), established in 2005, which limits emissions from more than 15,000 major emitters such as airlines, power stations and large industrial plants

Risk management

accounting for approximately 45 per cent of the EU’s GHG emissions. The scheme has been criticized, however, for its generous caps and surplus of permits, meaning that the carbon price has been lower than many, particularly environmental NGOs, would have liked. In May 2017, a tonne of carbon cost just €4.40, but reforms to the scheme, particularly reducing the supply of permits, have resulted in the carbon price rising to close to €100 per tonne during 2022, although this is in part explained by the war in Ukraine. In the UK, a national version of the ETS scheme will continue post-Brexit. Other emissions trading schemes operate at the national and/or regional level in countries that include the US, Japan, India and New Zealand. The World Bank has identified 65 current carbon pricing initiatives in operation, covering approximately 20 per cent of global greenhouse gas emissions (the majority are emissions trading schemes).57 Significantly, China recently launched (2021) a carbon trading scheme to cover the power generation sector (which in China is still heavily dependent on coal). This encompasses over 2,000 power generation facilities, accounting for roughly 40  per cent of the country’s total emissions (and 15 per cent of total global CO2 emissions). In time, cement, steel, aluminium, chemicals and petrochemicals will also be included, covering nearly 75 per cent of China’s total emissions, making this the world’s largest emissions trading scheme.58 The International Monetary Fund (IMF) estimates that a global carbon price of $75 per tonne is required by 2030 to reduce emissions to a level consistent with 2°C of global warming, and has proposed that this level should be set as the carbon price floor in advanced economies, with lower floors in emerging and developing economies.59 At present, however, the global average carbon price is less than $3 per tonne (2021), with the price varying considerably worldwide from less than $0.5 dollars per tonne in some jurisdictions to nearly $140 per tonne in Sweden.60 According to the Bank of England, orderly net zero transition scenarios suggest that global carbon pricing of approximately $100 per tonne is required by 2030, with the price continuing to rise in future years beyond that date.61

QUICK QUESTION What is the current carbon price in the country where you live/work, or in a country or region you are familiar with? How has the price changed over time? For realtime carbon prices from around the world, see https://carbonpricingdashboard. worldbank.org/map_data

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Wide variations in carbon pricing make it difficult to compare approaches, organizations and jurisdictions, and to quantify and price climate-related financial risks on this basis. Despite this, the number of organizations using carbon pricing to inform their business strategy and risk management is rising. The development of TCFDaligned disclosures, including the use of scenario analysis, will see this trend continue as projected future carbon prices become a key input into firms’ strategic and risk management decisions. The CDP reports that the number of large, international organizations using carbon pricing to support decision making and disclosure grew from 150 in 2014 to more than 2,000 by 2020, including an 80 per cent increase in the five years following the signing of the Paris Agreement. This includes almost half of the world’s largest 500 companies by market capitalization.62 The CDP also found that the use of carbon pricing is growing most quickly in the financial services sector. This is driven by central banks’ and regulators’ focus on identifying, measuring and disclosing climate and environmental risks. The Bank of England, for instance, required financial institutions to model the implications of higher carbon prices in its 2021 climate stress tests, and other central banks and regulators are taking similar approaches. Based on the Bank’s orderly transition scenario, with a carbon price of $100 per tonne in 2030 many financial institutions – particularly those heavily exposed to high-emitting sectors (such as power generation, petrochemicals, transport) – will face significant asset and loan impairment. According to the Financial Times, coal-based businesses could lose 90 per cent of their value, and energy sector firms 40 per cent on average. There are also sectors, firms and technologies that could gain from higher, consistent, global carbon ­pricing  – especially renewables, clean transport, and carbon capture and storage.63 As noted above, there are large differences between carbon prices in different countries and regions, and this can result in ‘carbon leakage’. This occurs when firms responsible for significant levels of greenhouse gas emissions move from jurisdictions with high carbon prices (taxes or ETS permits) to ones with much lower carbon prices. Whilst it might be difficult or impossible for a coal-fired power station to move, given the costs and complexities of power transmission, it is feasible that the production of many high-carbon goods (such as petrochemicals) might be moved to low carbon price jurisdictions, and the goods then imported into the higher carbon price jurisdiction. The EU and others have therefore proposed ‘carbon border taxes’ to create a level playing field by placing a surcharge on imports according to their carbon footprint. This is a complex process, though, since the tax must not conflict with global trade rules and there needs to be agreement between a wide range of national and international governments and bodies. Nevertheless, the EU intends to introduce its Carbon Border Adjustment Mechanism in 2026.64

Risk management

Carbon offsetting As noted above, offsets may be purchased by individuals and organizations from a wide range of providers and markets and for a wide range of purposes, from offsetting the emissions from an international flight to compensating for emissions released during a carbon-intensive production process. Where this is not required by law or regulation, these are referred to as voluntary offsets, and the purchase, trading and development of instruments based on offsets is known as the voluntary carbon market. Offsetting enables individuals and organizations to compensate for their own greenhouse gas emissions by supporting projects to reduce and/or capture and store emissions elsewhere. For example: ●● ●●

forest conservation, afforestation and reforestation; biodiversity conservation (e.g. restoring peat bogs, which can store large amounts of carbon);

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investing in renewable energy generation in developing countries;

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providing clean and efficient cooking and heating equipment;

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removing greenhouse gases from the atmosphere (e.g. via carbon capture and storage, combusting methane).

QUICK QUESTION Have you ever purchased a carbon offset? If so, what was it for, how much did it cost, and do you know what project(s) it supported and the amount of emissions offset?

Many definitions of and commitments to ‘net zero’ and ‘carbon neutrality’, such as those we introduced in Chapter 3, allow for the offsetting of emissions. At present, many financial institutions offset their Scope 1 and 2 emissions from areas including office and data centre heating and cooling, and employee travel. Scope 3 emissions from lending, investment and underwriting activities are rarely included. In Chapter 4 we saw that recent guidance for financial institutions by the Science-based Targets Initiative allows offsetting to be used only to support residual emissions once financed emissions have been substantially removed from lending and investment portfolios. The use of offsetting has been criticized on several grounds, including: ●●

It does not incentivize reductions in greenhouse gas emissions – critics claim that offsetting allows and enables emitters to avoid taking action to reduce emissions

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and is therefore a form of greenwashing. Offsetting may be a valid tool to be used alongside emissions reduction, but should not be used as a substitute. ●●

●●

●●

The quality of offsets varies considerably, with many different (and competing) offsetting schemes, plus standards, labels, consultants and providers that verify and certify offsets. Generally, the higher the cost, the higher the quality of the offset is likely to be, reflecting both the costs and complexity of the offsetting projects and the increased levels of assurance, verification and certification required. Concerns that the environmental benefits of offsetting projects are overstated. Some offsetting funds activities would have happened anyway (or were already happening) – i.e. they are not additional. Some offsetting projects may be reversed at a later stage (e.g. trees are planted and then cut down), meaning they are not permanent. Offsetting can be seen as a form of greenwashing, where only a small difference is made to an organization’s sustainability but that difference is strongly advertised and promoted.

A further issue is the wide variation in the prices of voluntary offsets, which differ according to the type of offset, its ‘quality’ (see above), and the provider. According to the World Bank (2022), based on data from S&P Global Platts, prices at the end of Q1 2022 ranged from approximately $6 per tonne for renewable energy projects to $20 per tonne for carbon removal projects, with all categories experiencing significant increases from the equivalent period in 2021 and the total value of voluntary offsets exceeding $1 billion for the first time that year.65 BloombergNEF forecasts that by 2050 the price of offsets could increase to between $47 and $150 per tonne, with a market valued at some $550 billion.66 To overcome issues of quality, several verification schemes have been established to verify and/or certify offsets meeting agreed criteria, often based on requirements for offsets to be additional (they would not have happened anyway), permanent environmental benefits properly evaluated and reported, and not associated with causing environmental or social harm. Established schemes include Verra’s ‘Verified Carbon Standard’67 and accreditation by the International Carbon Reduction and Offset Alliance (ICROA).68 The Voluntary Carbon Markets Integrity Initiative (VCMI) is developing global guidance and a carbon offset credits Code of Practice (to be published in 2022) that is science-based, rigorous and whose governance includes input from governments, civil society organizations and indigenous peoples, as well as purchasers of offsets.69 To accelerate the development of the voluntary carbon market to scale up the use of offsets whilst maintaining their quality, in 2020 the Institute of International

Risk management

Finance launched the Taskforce on Scaling Voluntary Carbon Markets. The Taskforce developed proposals for a voluntary carbon market which would: ●●

●● ●●

connect the supply of carbon offset credits to demand in a seamless, cost-effective and transparent way; instil confidence and ensure credibility in credits being exchanged and transacted; and be scalable to meet the expected increase in demand due to increased climate change mitigation policy, regulation and activity.70

A new governance body has been established to take the Taskforce’s work forward – the Integrity Council for Voluntary Carbon Markets (IC-VCM). The IC-VCM is developing a Code of Practice, expected to be published in draft form in 2022, which aims to set global standards for high-quality carbon offset credits.71 In 2021, a group of eight financial institutions launched Carbonplace, a blockchain-powered settlement platform that aims to support the smooth transfer of certified carbon offset credits between buyers and sellers and to provide a record of ownership (to prevent double counting). The platform is expected to be fully operational by the end of 2022.72 This is another rapidly developing area, and it is recommended that Green and Sustainable Finance Professionals keep track of developments from the VCMI, IC-VCM, Carbonplace and other bodies as the voluntary carbon market (or markets) grows and develops over time. Despite the challenges of ensuring a consistent and rigorous global approach to carbon taxes, emissions trading schemes and offsetting, carbon pricing plays an increasingly important role in climate and environmental risk quantification and management. It helps boards, investors and lenders price climate and environmental risks more accurately, identify the likelihood of asset impairment and spot opportunities for profitable investment in low-carbon technologies. As more jurisdictions introduce carbon taxes or trading schemes covering increasing quantities of global greenhouse gas emissions, as carbon offsetting becomes more rigorous and consistent and as the price of carbon rises, the true costs of the carbon externality will become increasingly reflected in economic and financial decision making, accelerating the whole-economy decarbonization and transition needed to achieve the objectives of the Paris Agreement.

Key concepts In this chapter, we considered: ●● ●●

the nature and importance of key climate-related and environmental risks; different types of climate-related risks (physical, transition and liability) and their impact on the finance sector;

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the emergence of climate-related and environmental risks as priorities for central banks, regulators and policymakers; and approaches to identifying, disclosing and managing climate-related risks, the use of scenario analysis and the evolving regulatory agenda.

Now go back through this chapter and make sure you fully understand each point.

Review Understanding, identifying, measuring, managing and disclosing climate, environmental and sustainability risks – especially climate risks – has become a priority in recent years for policymakers, central banks, financial regulators and the financial services sector. It is now understood that those risks are significant for customers, businesses, financial institutions and the economy and society overall, in the short, medium and long terms, and have the potential to threaten institutional and global financial stability. Climate, environmental and sustainability risks can be treated as standalone risks, but are increasingly considered as cross-cutting (transverse) risks that impact many other types of risk faced by organizations. Financial institutions’ strategies and activities are both informed by, and respond to, how climate, environmental and sustainability risks are identified and assessed. A strategic approach to risk management is developed through a firm’s risk governance framework, risk management system, controls and reporting, and risk appetite. Climate and environmental risks can be classified as physical, transition and liability risks (though sometimes liability risks are grouped together with transition risks). Physical risks are those that arise from the direct impacts of climate change and other environmental factors such as droughts, floods and storms. Physical risks may be divided into: ●●

acute risks – with severe, short-term impacts, such as floods or hurricanes; and

●●

chronic risks – with gradual, longer-term impacts, such as rising sea levels.

Transition risks are those that arise from the move to a low-carbon economy, and may be divided into: ●● ●●

risks from developments in climate policy, legislation and regulation; risks from new, lower-carbon technologies that replace existing products and services;

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risks from changing consumer behaviour and investor sentiment; and

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reputational risks.

Liability risks include costs that arise from litigation prompted by climate change and/or environmental harms, and the potential costs from legal challenges that seek

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to pressure companies and governments to do more to prevent these. The direct costs of such legal action can be significant; the longer-term costs arising from changes in legislation and regulation (or sentiment) because of legal action may be much higher. The implications of the whole-economy transition to net zero are systemic for all economic entities and activities. Some face an existential threat unless they transform their business models in response to transition risks. This creates substantial risks to financial institutions lending to or investing in these. Physical, transition and liability risks may result in stranded assets that suffer from unanticipated or premature write-downs, devaluations or conversion to liabilities. An abrupt, disorderly transition, where governments and others are forced into taking swift action in response to, or to avoid, catastrophic climate change could lead to a ‘climate Minsky moment’ and threaten financial stability. In all scenarios, the impacts of climate-related and other environmental and sustainability risks will increase due to global warming. The Task Force on Climate-related Financial Disclosures (TCFD) has established a framework for climate-related financial risk disclosures for use by companies providing information to investors, lenders, insurers and other stakeholders; it is designed to encourage consistency in identifying, disclosing and managing these risks. By promoting more consistent and comparable disclosures, climate-related financial risks should become more central to board and investor decision making, to shareholder engagement with management on climate change issues, and should assist central banks and regulators in their supervisory activities. The prudential and systemic risks created by climate change explain why central banks and financial regulators are increasingly adopting a coordinated, harmonized approach to the supervision of climate and environmental risks. The TCFD approach is now being mandated in an increasing number of jurisdictions, and regulation and guidance on climate and environmental risks are being rapidly developed and implemented through bodies including the Network for Greening the Financial System (NGFS). Some regulators and others are also now considering nature-related and broader categories of environmental and sustainability risks, and the Taskforce on Nature-related Financial Disclosures (TNFD) has been recently established to develop disclosure recommendations similar to those in place for climate-related risks. It is difficult for organizations and investors to understand, model and quantify climate risks due to the complexity and interrelated nature of the variables involved. It is also difficult to estimate the financial impacts of climate-related risks, as they depend on the degree of global warming, the speed of transition, changing regulation, the cost of legal liabilities and many other variables. Scenario analysis is a useful technique to use when attempting to understand the impact of different assumptions regarding the speed and impacts of climate change on products, services, organizations and investment portfolios. The increasing availability of credible, consistent and comparable data is helping institutions assess and model climate and environmental risks.

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Carbon pricing also plays an important role in climate and environmental risk quantification and management, helping boards, investors and lenders price climate and environmental risks more accurately. As more jurisdictions introduce carbon taxes or emissions trading schemes, as carbon offsetting becomes more rigorous and consistent, and as the price of carbon rises, the cost of carbon will become increasingly reflected in economic and financial decision making, accelerating the whole-economy decarbonization and transition needed to achieve the objectives of the Paris Agreement. Table 5.5  Key terms Term

Definition

Acute risks

Risks from severe, short-term environmental events such as floods or hurricanes.

Cap-and-trade scheme

Where organizations (usually large firms and/or major emitters of greenhouse gases) purchase permits that allow them to emit greenhouse gases, and can buy and sell these to others.

Carbon border tax

Charges on imports based on their carbon footprint to prevent cheaper imports from jurisdictions with lower carbon prices.

Carbon offset credit

A transferrable instrument, usually certified by a credible verification organization, representing a reduction in emissions of CO2e.

Carbon offsetting

Compensating or cancelling out all or a portion of the greenhouse gas emissions released to the atmosphere through investments in activities that reduce or remove an equivalent amount of emissions.

Carbon pricing

Assigning an economic value to carbon to create an incentive for firms to invest in low-carbon technologies and reduce carbon use.

Chronic risks

Risks from longer-term environmental changes such as rising sea levels.

Financial Stability Board (FSB)

The FSB is comprised of central banks, public international financial institutions and international standard-setting organizations. It has a mandate to strengthen financial systems and promote international financial stability.

Liability risks

Risks arising from parties who have suffered loss from the effects of climate change, or environmental damage and/or social harms, and who seek compensation from those they hold responsible.

Minsky Moment

A dramatic collapse in asset values, and in financial markets overall.

Network for Greening the Financial System (NGFS)

An organization of 114 central banks and financial regulators aiming to accelerate and coordinate regulatory approaches to climate risk and wider environmental risks, and to support the mainstreaming of green finance. (continued )

Risk management

Table 5.5  (Continued) Term

Definition

Physical risks

Risks arising from the direct impacts of climate-related hazards inherent in human and natural systems, such as droughts, floods and storms.

Scenario analysis

A well-established method for developing strategic plans that consider a range of future states.

Stranded asset risk

The risk of assets suffering from unanticipated or premature write-downs, devaluations or conversion to liabilities.

Taskforce on Climate-related Financial Disclosures (TCFD)

Established in 2015 by the Financial Stability Board, the TCFD has developed a global framework for the voluntary disclosure of climate-related financial risks.

Taskforce on Established in 2021, the TNFD brings together financial institutions, Nature-related governments, international organizations and NGOs to steer Financial finance towards outcomes that are nature-positive. Disclosures (TNFD) Taskforce on Scaling Voluntary Carbon Markets.

Established in 2020 by the Institute of International Finance, the Taskforce aims to develop proposals to accelerate the development of the voluntary carbon market to scale up the use of offsets whilst maintaining their quality,

Transition risks

Risks arising from the transition to a lower-carbon economy, such as developments in climate policy, new disruptive technology and shifting investor sentiment.

Voluntary carbon market

The purchase, trading and development of instruments based on voluntary carbon offset credits.

Notes 1 World Economic Forum (2022) The Global Risks Report 2022, https://www3.weforum. org/docs/WEF_The_Global_Risks_Report_2022.pdf (archived at https://perma.cc/ E3VX-6E3U) 2 Munich RE (2022) Natural catastrophes in 2021, https://www.munichre.com/content/ dam/munichre/mrwebsiteslaunches/natcat-2022/2021_Figures-of-the-year.pdf/_jcr_ content/renditions/original./2021_Figures-of-the-year.pdf (archived at https://perma.cc/ QD6T-9BMW) 3 Swiss Re (2021) World economy set to lose up to 18% GDP from climate change, https:// www.swissre.com/media/press-release/nr-20210422-economics-of-climate-change-risks. html (archived at https://perma.cc/7BGL-LKRM)

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Risk management 20 Chartered Banker (nd) Certificate in Climate Risk, https://www.charteredbanker.com/ qualification/certificate-in-climate-risk.html (archived at https://perma.cc/W9EE-ZMNZ) 21 ING (2022) ING Climate Report 2022, https://www.ing.com/Newsroom/News/ ING-publishes-climate-report.htm (archived at https://perma.cc/A5C8-UVHB) 22 FSB (2020) Home, https://www.fsb.org (archived at https://perma.cc/7JL8-AG4Z) 23 FSB (2015) Proposal for a disclosure task force on climate-related risks, https://www.fsb. org/wp-content/uploads/Disclosure-task-force-on-climate-related-risks.pdf (archived at https://perma.cc/Z97F-WQN8) 24 FSB (2020) Stocktake of financial authorities’ experience in including physical and transition climate risks as part of their financial stability monitoring, https://www.fsb. org/2020/07/stocktake-of-financial-authorities-experience-in-including-physical-andtransition-climate-risks-as-part-of-their-financial-stability-monitoring/ (archived at https://perma.cc/P56Q-KL5Y) 25 NGFS (2022) About Us: Membership, https://www.ngfs.net/en/about-us/membership (archived at https://perma.cc/4SDE-474Y) 26 NGFS (2020) Survey on monetary policy operations and climate change: key lessons for further analyses, https://www.ngfs.net/en/survey-monetary-policy-operations-and-climatechange-key-lessons-further-analyses (archived at https://perma.cc/VB3W-KEWY) 27 NGFS (2021) Guide on climate-related disclosure for central banks, https://www.ngfs. net/sites/default/files/medias/documents/guide_on_climate-related_disclosure_for_central_ banks.pdf (archived at https://perma.cc/DV7R-MM4K) 28 NGFS (nd) Scenarios Portal, https://www.ngfs.net/ngfs-scenarios-portal/ (archived at https://perma.cc/5ADF-HA6C) 29 NGFS (2022) NGFS Climate Scenarios for central banks and supervisors, https://www. ngfs.net/en/ngfs-climate-scenarios-central-banks-and-supervisors-september-2022 (archived at https://perma.cc/AD7D-YQQD) 30 TCFD (2017) Recommendations of the Task Force on Climate-related Financial Disclosures, https://assets.bbhub.io/company/sites/60/2020/10/FINAL-2017-TCFDReport-11052018.pdf (archived at https://perma.cc/7CG6-ZDR3) 31 Ibid 32 TCFD (2021) Implementing the Recommendations of the Task Force on Climate-related Financial Disclosures, https://assets.bbhub.io/company/sites/60/2021/07/2021-TCFDImplementing_Guidance.pdf (archived at https://perma.cc/JY82-LAK9) 33 PRI (2021) Climate Reporting to PRI, https://www.unpri.org/climate-change/climatereporting-to-the-pri/7131.article (archived at https://perma.cc/2YHH-697M) 34 IPCC (2018) Climate Scenario Development, https://www.ipcc.ch/site/assets/ uploads/2018/03/TAR-13.pdf (archived at https://perma.cc/PZ6S-5LHK) 35 Shell Scenarios (2018) Sky: Meeting the goals of the Paris Agreement, https://www. ourenergypolicy.org/wp-content/uploads/2018/03/shell-scenarios-sky-1.pdf (archived at https://perma.cc/Z6SA-KPWQ) 36 TCFD (2017) The Use of Scenario Analysis in Disclosure of Climate-related Risks and Opportunities, https://assets.bbhub.io/company/sites/60/2020/10/FINAL-TCFDTechnical-Supplement-062917.pdf (archived at https://perma.cc/9GZQ-VGZ7)

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Green and Sustainable Finance 37 TCFD (2020) Guidance on Scenario Analysis for Non-Financial Companies, https:// assets.bbhub.io/company/sites/60/2020/09/2020-TCFD_Guidance-Scenario-AnalysisGuidance.pdf (archived at https://perma.cc/VQC7-SV4A) 38 UNEP FI (2021) Pathways to Paris: A practical guide to climate transition scenarios for financial professionals, https://www.unepfi.org/publications/climate-change-publications/ tcfd-publications/pathways-to-paris/ (archived at https://perma.cc/S7A4-5CE9) 39 TCFD (2017) Technical Supplement: The use of scenario analysis in disclosure of climate-related risks and opportunities, https://assets.bbhub.io/company/sites/60/2020/10/ FINAL-TCFD-Technical-Supplement-062917.pdf (archived at https://perma.cc/9GZQVGZ7); IPCC (nd) Criteria for Selecting Climate Scenarios, https://www.ipcc-data.org/ guidelines/pages/scen_selection.html (archived at https://perma.cc/87N6-WFW3) 40 Bank of England (2021) Bank of England publishes the key elements of the 2021 Biennial Exploratory Scenario: Financial risks from climate change, https://www.bankofengland. co.uk/news/2021/june/key-elements-of-the-2021-biennial-exploratory-scenario-financialrisks-from-climate-change (archived at https://perma.cc/84JV-P8MB) 41 Bank of England (2022) Results of the 2021 Climate Biennial Explanatory Scenario (CBES), https://www.bankofengland.co.uk/stress-testing/2022/results-of-the-2021climate-biennial-exploratory-scenario (archived at https://perma.cc/7LHK-EVR3) 42 UN: Sustainable Development Goals (2019) UN Report: Nature’s dangerous decline ‘unprecedented’; species extinction rates ‘accelerating’, https://www.un.org/ sustainabledevelopment/blog/2019/05/nature-decline-unprecedented-report/ (archived at https://perma.cc/38MP-D8QG) 43 UNEP (2021) State of Finance for Nature, https://www.unep.org/resources/state-financenature (archived at https://perma.cc/HM8C-EL46) 44 HM Treasury (2021) The Economics of Biodiversity – the Dasgupta Review, https:// www.gov.uk/government/publications/final-report-the-economics-of-biodiversity-thedasgupta-review (archived at https://perma.cc/PWX4-3XD4) 45 De Nederlandsche Bank (2020) Indebted to Nature – Exploring Biodiversity Risks for the Dutch Financial Sector, https://www.dnb.nl/media/4c3fqawd/indebted-to-nature.pdf (archived at https://perma.cc/5KLJ-RZ49) 46 WEF (2020) Nature Risk Rising: Why the crisis engulfing nature matters for business and the economy, https://www3.weforum.org/docs/WEF_New_Nature_Economy_ Report_2020.pdf (archived at https://perma.cc/S3WB-R9G9) 47 WEF (2020) The Future of Nature and Business, https://www3.weforum.org/docs/ WEF_The_Future_Of_Nature_And_Business_2020.pdf (archived at https://perma.cc/ V85N-M93N) 48 TNFD (nd) Home (TNFD Global), https://tnfd.global (archived at https://perma.cc/ JHB6-9USD) 49 TNFD (nd) The TNFD Framework, https://tnfd.global/the-tnfd-framework/ (archived at https://perma.cc/7DRB-GN2N) 50 EBA (2022) EBA publishes binding standards on Pillar 3 disclosures on ESG risk, https:// www.eba.europa.eu/eba-publishes-binding-standards-pillar-3-disclosures-esg-risks (archived at https://perma.cc/ADT3-QHSB)

Risk management 51 US Securities and Exchange Commission (2022-46) SEC proposes rules to enhance and standardize climate-related disclosures for investors, https://www.sec.gov/news/pressrelease/2022-46 (archived at https://perma.cc/JJ2H-3UNR) 52 CBN Editor (2021) Chinese Central Bank to launch climate-related financial disclosure requirements, drive green transformation of domestic lenders, https://www. chinabankingnews.com/2021/06/06/chinese-central-bank-to-launch-climate-relatedfinancial-disclosure-requirements-drive-green-transformation-of-domestic-lenders/ (archived at https://perma.cc/5DKE-YU83) 53 MAS (2020) Guidelines on environmental risk management for banks, https://www.mas. gov.sg/regulation/guidelines/guidelines-on-environmental-risk-management (archived at https://perma.cc/5CJR-S9JB) 54 FCA (2022) Climate Financial Risk Forum, https://www.fca.org.uk/transparency/climatefinancial-risk-forum (archived at https://perma.cc/6ENS-694X) 55 C2ES (nd) Carbon Tax Basics, https://www.c2es.org/content/carbon-tax-basics/ (archived at https://perma.cc/TGQ6-DKER) 56 VCMI (2021) Aligning voluntary carbon markets with the 1.5°C Paris Ambition, https:// vcmintegrity.org/wp-content/uploads/2021/07/VCMI-Consultation-Report.pdf (archived at https://perma.cc/3B5Y-SEAK) 57 The World Bank (2022) Carbon Pricing Dashboard, https://carbonpricingdashboard. worldbank.org/map_data (archived at https://perma.cc/3FTF-7FKK) 58 Carbon Brief (2021) In-depth Q&A: Will China’s emissions trading scheme help tackle climate change? https://www.carbonbrief.org/in-depth-qa-will-chinas-emissions-tradingscheme-help-tackle-climate-change/ (archived at https://perma.cc/BGG7-55CM) 59 IMF (2021) Proposal for an international carbon price floor among large emitters, https://www.imf.org/en/Publications/staff-climate-notes/Issues/2021/06/15/Proposal-foran-International-Carbon-Price-Floor-Among-Large-Emitters-460468 (archived at https:// perma.cc/RG43-B34F) 60 The World Bank (2022) Carbon Pricing Dashboard, https://carbonpricingdashboard. worldbank.org/map_data (archived at https://perma.cc/3FTF-7FKK) 61 Bank of England (2021) The Bank of England and Climate Action, https://www. bankofengland.co.uk/-/media/boe/files/events/2021/january/climate-action-slides.pdf?la= en&hash=AFAB3CD4CE031318642E038106974F9C06695D0D (archived at https:// perma.cc/E5Z3-9JEA) 62 CDP (2021) Putting a Price on Carbon: The state of internal carbon pricing by corporates globally, https://cdn.cdp.net/cdp-production/cms/reports/documents/000/005/651/ original/CDP_Global_Carbon_Price_report_2021.pdf?1618938446 (archived at https:// perma.cc/BS84-VAPH) 63 Financial Times (2021) Lex in-depth: How carbon prices will transform industry, https:// www.ft.com/content/0412fb34-8691-4443-bc85-0103ee99cf70 (archived at https:// perma.cc/W5H7-FTK3) 64 Europa Commission (nd) Carbon Border Adjustment Mechanism, https://ec.europa.eu/ taxation_customs/green-taxation-0/carbon-border-adjustment-mechanism_en (archived at https://perma.cc/9V46-ZGLJ)

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Green and Sustainable Finance 65 World Bank (2022) State and Trends of Carbon Pricing 2022, https://openknowledge. worldbank.org/handle/10986/37455 (archived at https://perma.cc/Z5RD-ENKS) 66 BloombergNEF (2022) Carbon offset prices could increase fifty-fold by 2050, https:// about.bnef.com/blog/carbon-offset-prices-could-increase-fifty-fold-by-2050/ (archived at https://perma.cc/8YK5-FPTU) 67 Verra (2022) The world’s leading voluntary GHG program, https://verra.org/project/ vcs-program/ (archived at https://perma.cc/LR5C-A8A8) 68 ICROA (2021) Home, https://www.icroa.org (archived at https://perma.cc/G8LH-S4YQ) 69 VCMI (2021) Home, https://vcmintegrity.org (archived at https://perma.cc/K6S2-T8UQ) 70 TSVCM (2021) Taskforce on Scaling Voluntary Carbon Markets (2021): Final Report, https://www.iif.com/Portals/1/Files/TSVCM_Report.pdf (archived at https://perma.cc/ 9V94-URZ5) 71 ICVCM (2022) Home, https://icvcm.org (archived at https://perma.cc/6ZZ8-PPSE) 72 Carbonplace (nd) Home, https://carbonplace.com/# (archived at https://perma.cc/ 9PJV-PV25)

6

Responsible retail, commercial and corporate banking Introduction Banks are well positioned to respond to (and shape) consumer preferences, reallocate credit and mobilize capital towards environmentally and socially sustainable economic activities. They play a key role in a successful societal transition to net zero. There are four main types of banks, each of which plays a different role in the economy and offers different types of products and services: retail banks serving individuals and small businesses, corporate and investment banks serving larger clients, central banks, and national and multilateral development banks. This chapter focuses on retail, corporate and investment banks, and describes how banking can be aligned with the objectives of the Paris Agreement and the UN Sustainable Development Goals. Several important banking sector initiatives for improving the alignment of banks’ strategies and activities with green and sustainable finance principles, promoting market consistency and integrity and avoiding greenwashing are examined. These include the UN Principles for Responsible Banking, the UN-convened Net Zero Banking Alliance, and the Green Loan, Social Loan and Sustainability Linked Loan Principles. The growing number of green and sustainable banking products and services developed to encourage and support environmentally and socially sustainable economic activities are introduced and described.

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L E A R N I N G OB J ECTI VES On completion of this chapter you will be able to: ●●

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Describe how banking can impact the environment and society – both positively and negatively – and how it plays a key role in a successful transition to net zero. Describe the UN Principles for Responsible Banking and the Net Zero Banking Alliance, and how these support the alignment of banking with the objectives of the Paris Agreement and the UN Sustainable Development Goals. Describe how banking products and services can align finance with the Paris Agreement and other sustainability objectives, and support customers and clients in adopting more sustainable business models and behaviours. Describe the Green Loan Principles, Social Loan Principles and Sustainability Linked Loan Principles. Cite examples and case studies of innovative responsible, green and sustainable banking products and services.

The role of banking in the transition to a sustainable, low-carbon world The banking system provides many critical services to individuals, businesses and the economy and society overall. These include taking deposits, creating and allocating credit, managing the payments system, underwriting securities, raising finance in capital markets, offering savings and investment products, providing advisory services and undertaking research. In practice, many banks offer products and services across more than one of these functions. Some banks also offer other services, such as asset management, wealth management and insurance. The term ‘banking’ can be applied to a large range of financial institutions that cater to a diverse range of clients, regions and sectors, from large global banks that serve multinational corporations across many jurisdictions to small, mutually owned building societies and credit unions that serve local households and businesses. Public banks also play important roles in many countries. In this book we distinguish between the following four types of banks: ●●

Retail banks, primarily offering products and services to individuals and small business customers (the latter is sometimes referred to as ‘commercial banking’) – these may include public and private banks, building societies, credit unions and cooperative banks.

Responsible retail, commercial and corporate banking ●●

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Corporate and investment banks (also called ‘wholesale banking’) serving larger, corporate clients and other financial institutions. National and multilateral development banks, such as KfW (the German Development Bank), the Asian Development Bank and the World Bank. Central banks, such as the Bank of England and the People’s Bank of China, which act as financial services regulators and hold ‘lender of last resort’ responsibilities.

In this chapter, we introduce and provide an overview of green and sustainable banking products and services in retail, commercial and corporate banking, whilst Chapter 7 considers the market for green bonds and other debt (‘fixed income’) securities in more detail. Central banks’ role in development is covered separately in Chapter 8, and the use of FinTech tools and techniques in relation to banking is explored further in Chapter 11. Banks are the main source of credit for households and firms in most economies, and play major roles in capital markets, too. Lending and investment decisions made by banks therefore have material consequences on the environment – both positive and negative. Banks are uniquely positioned to reallocate credit and mobilize capital away from environmentally harmful activities and towards green and sustainable projects and activities. By continuing to finance high-carbon, environmentally or socially damaging activities, however, banks contribute to the acceleration and impacts of climate change, and to wider environmental and societal harms (e.g. deforestation and habitat loss). All types of retail and corporate banks, large and small, play key roles in both ‘greening finance’ and ‘financing green’ (terms introduced in Chapter 1) in the context of aligning banking overall with the objectives of the Paris Agreement and the UN Sustainable Development Goals (SDGs).

QUICK QUESTION What are some of the ways in which banks you are familiar with are aligning their activities with the Paris Agreement and the UN SDGS?

Greening finance Many banks now embed, or are in the process of embedding, environmental and other sustainability factors into their strategies, activities and operations. This includes: ●●

making public commitments to achieving net zero emissions by 2050, incorporating science-based targets (see Chapter 4), and aligning lending and investment portfolios with global warming limited to 1.5°C above pre-industrial levels (see below);

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integrating environmental, climate-related and other sustainability risk factors into banks’ risk management systems, especially credit risk management (as discussed in Chapter 5); developing and mainstreaming retail and corporate banking products and services that deliver positive environmental and/or social impacts alongside financial returns and other benefits for customers (these are introduced later in this chapter); decarbonizing lending and investment portfolios by reducing and/or refusing lending to high-carbon sectors and firms, especially thermal coal and, increasingly, other fossil fuels (combined with increasing lending to sustainable alternatives – see below); and building institutional capacity, capability and cultures to support the above.

To date, the key drivers of this have been regulatory pressure and the mitigation of financial losses from physical and transition risks. More recently, however, banks – especially those that are signatories to the UN Principles for Responsible Banking, members of the Net Zero Banking Alliance and other similar groups – have been more proactively seeking to achieve positive environmental and social impacts by including sustainability in the design and delivery of an increasingly wide range of retail and corporate banking products and services. Another important driver is changing customer sentiment and preferences, which banks wish to reflect and support by providing more environmentally and socially beneficial products and services. Banks are also aware, and seek to take advantage of, the substantial commercial opportunities presented by the economic and societal transition to net zero, as outlined in Chapter 1, both by developing new products and services and by aligning their lending activities with sustainability (i.e. ‘financing green’).

Financing green Retail and corporate banks can mobilize private capital for lending to and investment in environmentally and socially sustainable activities through loans and other debt products to households and firms, and through their advisory, intermediation and capital markets activities. These include: ●●

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increasing lending to individuals and families that delivers positive environmental and social impacts, such as green and retrofit mortgages and electric vehicles; prioritizing lending to environmentally sustainable sectors, firms, technologies and activities through green commercial mortgages, green and social loans and similar products; incentivizing organizations’ transitions from high- to low-carbon business models, technologies and activities via sustainability-linked and similar loans; and

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raising capital through equity IPOs for environmentally and socially sustainable firms and technologies, and underwriting the issue of green, sustainable and transition bonds to support more established firms and projects (green and other types of sustainable bonds are explored in detail in Chapter 7).

The key to successfully ‘financing green’ is engaging with clients and customers, both with individuals (to understand and help shape their preferences for more environmentally and socially sustainable banking products and services) and with organizations (to understand, assess and shape their plans for transition to low-carbon business models and technologies). The role of banks as trusted advisors to corporate clients in this respect is vital, as banks can share their expertise in climate risk, scenario analysis, target setting and other areas of developing credible transition plans with their clients. Rapidly and robustly building capacity, capabilities and cultures to support the above within individual institutions, and across banking as a whole, is needed, however, if banks, customers and clients are to achieve the objectives of the Paris Agreement and limit global warming to 2°C and ideally 1.5°C above pre-industrial levels by mid-century.

CASE STUDY SEB’s sustainability strategy1 SEB is a universal bank based in Sweden, with substantial operations in other Nordic countries and Germany, and a significant presence in corporate banking in many major global financial centres. The bank has been a pioneer in many aspects of green and sustainable finance. It helped develop the World Bank’s first Green Bond in 2007, and was one of the founding signatories of the UN Principles for Responsible Banking. The bank’s strategy, activities and operations seek to generate positive environmental and social returns and to minimize harm while providing financial returns for depositors, customers and investors. In 2021, SEB launched a refreshed sustainability strategy for the bank that forms part of its 2022–24 business plan and is a cornerstone of its longer-term 2030 strategy. The new strategy broadens the scope of SEB’s sustainability work (although it focuses initially on climate), clarifies SEB’s role in the transition towards a sustainable, low-carbon economy and further integrates environmental and social sustainability into the bank’s operations, products, processes and decision making. As part of SEB’s sustainability strategy, the bank has set new ambitions and goals for reducing its exposure to fossil fuels, increasing lending to environmentally and socially sustainable sectors and firms, and supporting its customers in their transitions to more sustainable, low-carbon business models. Regular public

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reporting on progress in the three areas below will be provided to enable the bank and its stakeholders to track progress: Carbon Exposure Index – ‘The Brown’ – a volume-based metric capturing SEB’s lending to the fossil fuel sector. The bank’s goal is to reduce fossil fuel exposure within the bank’s energy portfolio, including power generation and distribution, as well as oil and gas, by 45–60 per cent per cent by 2030 compared with a 2019 baseline. This approach means the bank will be in line with or outperforming the strictest 1.5°C degree-aligned climate scenarios provided by the Network for Greening the Financial System (NGFS). Sustainability Activity Index – ‘The Green’ – a volume-based metric capturing SEB’s sustainability-related lending and advisory activities, plus the bank’s Greentech venture capital investments. SEB’s aim is to increase average activity six to eight times by 2030 compared with a 2021 baseline. Transition Ratio – ’The Future’ – a volume-based ratio based on SEB’s internal Customer Sustainability Classification Model, which will assess the bank’s and customers’ climate impacts and alignment towards the objectives of the Paris Agreement. This will help the bank get a better understanding of customers’ transition journeys and the support needed to help them with these. Johan Torgeby, SEB’s President and CEO, said: As a bank, we have the power, opportunity and responsibility to impact the world we operate in. SEB wants to be a leading catalyst in the sustainability transition. We have an ambition to accelerate the pace towards a sustainable future for people, businesses and society, and we believe we can make the greatest positive impact for the climate by partnering with our customers and supporting them on their transition journeys. As the next step in our sustainability strategy, we have set growth ambitions for our sustainable products, advisory services and investments while at the same time laying out a clear and concrete path for the reduction of our fossil credit exposure.

Despite the recent growth in green and sustainable finance, however, the banking sector still often contributes to increasing greenhouse gas emissions and other environmental and social harms rather than reducing them. In Chapter 1, we saw that some 60 global banks have provided financing of more than $4.6 trillion to the fossil fuel sector since the signing of the Paris Agreement in 2015, which substantially outweighs their financing of sustainable, low-carbon alternatives.2 Overall, bank lending and underwriting to the fossil fuel sector increased each year following the

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signing of the Paris Agreement in 2015 to $824 billion in 2019, before falling back to $742 billion in 2021.3 Civil society organizations play an important role in monitoring banks’ climate change, environmental and social sustainability commitments. ShareAction’s 2020 Banking on a Low Carbon Future report, for example, compared and ranked the top 20 global banks in terms of their sustainability commitments and announcements, and action taken by them to implement these.4 ShareAction found that, at that time, most of the banks surveyed had not substantially aligned their strategies, activities and operations with sustainability, instead opting for a business-as-usual approach. In 2021, ahead of COP26, ShareAction assessed how the 25 largest European banks approached critical climate and biodiversity themes,5 reporting that, although 20 of these had committed to net zero targets by 2050, very few had detailed plans in place to achieve them. Similarly, the Cambridge Institute for Sustainability Leadership (CISL) found in its Bank 2030: Accelerating the transition to a low carbon economy report that banks needed to be more proactive in integrating sustainability into their strategic planning.6 According to the CISL, most banks continued to take a passive or ‘banking-as-usual’ approach to sustainability, preferring to be client-led rather than seeking to lead and support clients in their transitions to net zero. These are important concerns, and should not be dismissed. If banks continue to fund environmentally and socially damaging sectors, firms, technologies and activities, and do not genuinely align their strategies, activities and operations with the objectives of the Paris Agreement and UN Sustainable Development Goals, then banks and banking are, quite literally, unsustainable – and can justifiably be accused of greenwashing. For a whole-economy and whole-society transition to succeed, banks must support their public commitments with detailed strategies, plans and targets that accelerate both ‘greening finance’ and ‘financing green’, as set out above, supported by investments in capacity and capabilities to ensure that these can be achieved in the challenging timescales required.

UN Principles for Responsible Banking and Net Zero Banking Alliance The UN Principles for Responsible Banking In recent years, moves to align banking with environmental and social sustainability have gathered pace, driven by a combination of evolving policy and regulation, changing customer, employee and investor attitudes, and in particular the recognition of the key role of banking in addressing climate change and other sustainability

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issues. Amongst the most significant global initiatives, building on the Principles for Responsible Investment (see Chapter 9) and the Principles for Sustainable Insurance (see Chapter 10), is the UN Principles for Responsible Banking, (PRB) launched in 2019.7 The PRB’s aim is to align banks’ strategies, activities and operations with the Paris Agreement and UN Sustainable Development Goals (SDGs), and to provide a global framework, a supportive peer network and target-setting, impact analysis and reporting mechanisms to support this. Within three years of the launch of the PRB (September 2022), some 300 banks representing approximately 45 per cent of global banking assets under management and serving some 2 billion customers and clients worldwide had become PRB signatories.8 There is a significant overlap in membership between the PRB and the UN-convened Net Zero Banking Alliance (NZBA), introduced in Chapter 3, and both are supported by the United Nations Environment Programme Finance Initiative (UNEP FI). The NZBA – the banking constituent alliance of GFANZ – focuses, as its name suggests, on climate, particularly on aligning banks’ lending and investment activities with net zero emissions by mid-century using science-based targets. The PRB encompasses climate as well as wider aspects of environmental and social sustainability as set out in the UN SDGs. In practice, a bank that meets the commitments it has made in joining the NZBA will also meet the requirements for PRB signatories in terms of climate. The Chartered Banker Institute was one of the first non-bank endorsers to support the PRB, viewing the Principles as entirely consistent with the Institute’s vision of banking as an ethical, socially purposeful and sustainable profession. The six Principles for Responsible Banking,9 which signatories commit to embedding in their bank’s strategies, activities and operations across all business areas, are as follows.

Principle 1: Alignment We will align our business strategy to be consistent with and contribute to individuals’ needs and society’s goals as expressed in the Sustainable Development Goals (SDGs), the Paris Climate Agreement and relevant national and regional frameworks.

Principle 2: Impact and target setting We will continuously increase our positive impacts while reducing the negative impacts on, and managing the risks to, people and environment resulting from our activities, products and services. To this end, we will set and publish targets where we can have the most significant impacts.

Responsible retail, commercial and corporate banking

Principle 3: Clients and customers We will work responsibly with our clients and our customers to encourage sustainable practices and enable economic activities that create shared prosperity for current and future generations.

Principle 4: Stakeholders We will proactively and responsibly consult, engage and partner with relevant stakeholders to achieve society’s goals.

Principle 5: Governance We will implement our commitment to these Principles through effective governance and a culture of responsible banking.

Principle 6: Transparency and accountability We will periodically review our individual and collective implementation of these Principles and be transparent about and accountable for our positive and negative impacts and our contribution to society’s goals. To help banks implement this substantial commitment across their business activities, UNEP FI has developed a three-step process comprising:

1) Impact analysis PRB signatories should analyse and identify the most significant impacts of their banks’ activities, operations, products and services on society, the environment and the economy (both positive and negative), aligned with the UN SDGs and working with internal and external stakeholders to do this. They should then identify areas where their institution can make the greatest positive impacts and reduce environmental and social harms caused by current activities, prioritizing the two most significant impact areas. To assist banks with impact analysis, UNEP FI has published guidance to support signatories, developed by some of the initial PRB signatories who have already completed their initial Impact Analysis.10

2) Target setting PRB signatories should set at least two targets that address the significant impact areas identified during the Impact Analysis stage. Targets should be SMART (specific, measurable, achievable, relevant and time-bound), interim milestones should be agreed and suitable governance and reporting arrangements put in place to oversee the achievement of the targets. According to the PRB, the majority (87 per cent) of signatories are setting targets to address climate mitigation and adaptation, with

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financial inclusion a key area for just under half (45 per cent) of banks,11 but signatories need to strengthen their impact analysis and target-setting activities and, in particular, ensure that the latter are linked to the former in terms of banks’ lending and investment activities. To assist banks with target setting in several areas aligned with the UN SDGs, including biodiversity, climate, financial inclusion, gender equality and the circular economy, UNEP FI has published a range of guidance to support signatories.12

3) Reporting PRB signatories are not required to produce a separate report on their activities relating to the PRB, but should include an annual assessment of alignment with and progress in implementing the PRB in existing public reporting. Within 18 months of becoming a signatory, banks must publish their first self-assessment of their alignment with the PRB. This should take the form of an initial impact analysis along the lines set out above, identifying their most significant impacts on society, the environment and the economy, and publishing at least two targets. Signatories have a four-year period in which to make significant progress towards the targets, and should self-assess and report annually on this. Limited external assurance of banks’ self-assessment is required. UNEP FI has published guidance for banks and assurance providers on PRB reporting,13 including a reporting and self-assessment template. Some signatories choose to report separately using this; others to integrate PRB reporting within their external reporting to regulators, investors and others.14

QUICK QUESTION Has your organization, or organizations you are familiar with, signed the principles for responsible banking? If so, can you find their reports?

The PRBs are a set of organizational principles for banks. For the Principles to succeed in aligning banks’ strategies and activities with the objectives of the Paris Agreement and the UN SDGs, and to build and continue to support a global culture of responsible, sustainable banking, the PRBs need to be embedded at the industry, institutional and individual levels: ●●

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Industry level: policymakers, regulators and industry trade associations leading a collective approach to endorsing and implementing the PRB. Institutional level: PRB signatories leading by example and sharing good practice.

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Individual level: professional bodies and educators such as the Chartered Banker Institute bringing the PRB to life for banking professionals, embedding them in professional standards, education and training, and qualifications, and setting out how they can be demonstrated by bank staff in their day-to-day professional banking practice.

As we will see in Chapter 12, mainstreaming green and sustainable finance – including the PRB – needs to be led by individuals committed to change. This means changing their individual professional practice to align their day-to-day activities with sustainability, and seeking to align the practice of others in their organization and, ultimately, the practice of the organization itself. To support the implementation of the PRB, therefore, the banking sector requires increasing numbers of Green and Sustainable Finance Professionals with an understanding of the critical role of financial services in supporting the transition to an environmentally and socially sustainable world. Banking professionals need to acquire relevant knowledge and skills to be able to develop and deploy financial products, services and tools that can mobilize capital to support that transition, address climate-related, environmental and societal risks, and support customers and communities through their own transitions to more sustainable business and economic models.

The Collective Commitment to Climate Action and the Net Zero Banking Alliance In 2019, a leadership group of 38 banks formed the Collective Commitment to Climate Action (CCCA)15 with the aim of fast-tracking the implementation of the PRB in relation to climate. This was done to help banks more rapidly integrate the PRB into their own strategies, activities and operations, and to develop expertise, guidance and tools that could be shared with other PRB signatories. In particular, the CCCA banks would set and publish targets for aligning lending and investment portfolios with the goals of the Paris Agreement, focusing on the most carbon-intensive and climate-vulnerable sectors within their portfolios. The CCCA has now been overtaken by the UN-convened Net Zero Banking Alliance (NZBA),16 introduced in Chapter 3, and UNEP FI now encourages PRB signatories to join the NZBA, which currently (2022) comprises more than 100 banks from 40 countries. As noted above, the NZBA is the banking constituent alliance of GFANZ, and there is a very substantial overlap between PRB signatories and NZBA members, with the great majority of NZBA members being PRB signatories (although the converse is not the case). The NZBA commitment, though, is more rigorous and robust in terms of climate alignment than the PRB, and requires banks to have substantial expertise in climate impact analysis and target setting, as well as access to the data required to perform these.

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Building on the work of the CCCA, NZBA members commit to aligning their lending and investment portfolios to limit global warming to 1.5°C above pre-industrial levels, and to: ●●

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transitioning operational and attributable GHG emissions from lending and investment portfolios to align with the pathways to net zero by 2050 or sooner; setting an interim 2030 target, with intermediary targets to be set every five years from 2030 onwards towards the 2050 overall target; focusing interim targets on priority sectors where the most significant impacts can be made; publishing absolute emissions and emissions intensity on an annual basis, and disclosing progress against a board-level reviewed transition strategy setting out proposed actions and climate-related sectoral policies; and taking a robust approach to the role of offsets in transition plans.17

The NZBA’s commitment relating to setting mid-century, 2030 and intermediary targets for decarbonizing lending and investment portfolios is underpinned by the Guidelines for Climate Target Setting for Banks, developed by UNEP FI (and also used by CCCA members and other PRB signatories setting climate-related targets).18 The Guidelines set out four key principles: 1 Banks should set and disclose long-term, interim and intermediate targets to support the objectives of the Paris Agreement and support the transition to net zero by 2050. 2 Banks should use credible, science-based targets when setting these, to ensure alignment with the objectives of the Paris Agreement. 3 Banks should establish a baseline for current emissions from lending and investment portfolios, and annually measure and report progress in reducing these, encompassing clients’ Scope 1, 2 and 3 emissions (there is a caveat ‘where data allows’, but it is also noted that coverage is expected to increase over time as this becomes more available). 4 Banks should regularly review targets to ensure consistency with current climate science, and update these as necessary. New members of the NZBA, and PRB signatories joining the CCCA after April 2021, are expected to apply the Guidelines and set their first round of targets within 18 months (i.e. by October 2022). Banks then have a further 18 months to set targets for all or the substantial majority of the carbon-intensive sectors to which they are exposed. Existing CCCA signatories (as of April 2021) have three years from the time of joining the CCCA to apply the Guidelines, and then a further 18 months to set targets for carbon-intensive sectors.

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In setting and achieving targets for reducing emissions from lending and investment portfolios, NZBA members are not expected or required to divest from high-carbon sectors and firms or completely withdraw from lending to these. This could form part of a long-term decarbonization strategy, but in recognition of the broader aspects of sustainability and the importance of ensuring a just transition, NZBA members are encouraged to work with clients and customers to support their transitions to more sustainable, low-carbon business models, and to design and deploy products and services that can support these, many of which we introduce below and in Chapter 7.

QUICK QUESTION Has your organization, or an organization you are familiar with, become a member of the NZBA? What targets has it set for 2030?

Retail banking products and services Retail banking is the provision of products and services by a bank to individual consumers and small and medium-sized businesses (SMEs), rather than to large corporations or other banks. Sometimes referred to as ‘community banking’, the term is generally used to distinguish these banking services from corporate, wholesale and investment banking, which we cover later in this chapter. It may also be used to refer to a division or department of a bank dealing with retail customers. With the growth of digital banking, other organizations, including mobile phone operators and technology companies, may offer retail banking services such as online payments or consumer finance. Sometimes they do so in partnership with established retail banks, and sometimes by competing against them. Retail banks and other organizations offering similar services play an important role in the financial system, performing three main functions: ●●

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Deposit taking: Retail banks are where individuals and SMEs can safely deposit their money. Without banks, people would have to store and protect their savings themselves, which would involve significant risks. Managing the payments system: Banks are responsible for the payments systems used to settle financial transactions. Digital payments are becoming more important as people use cash less, a trend that accelerated during the Covid-19 pandemic. Mobile operators, technology companies and FinTechs provide online payment services, either in partnership with established banks or as an alternative to ­traditional banks.

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Extending credit: Retail banks (and other organizations, including peer-to-peer lenders) extend credit to individuals and SMEs through loan and overdraft products. Without retail banks, it would be difficult for people to buy a home or for small businesses to access working capital or make investments. As the major source of credit in most economies, banks play a key role in lending to both highand low-carbon sectors and firms.

Products and services provided by retail banks and other providers to individuals include payments, current and savings accounts, mortgages, personal loans, overdrafts and debit and credit cards. SMEs are offered a range of business accounts, payment services, loans and asset finance. Retail banks can vary widely in scale; for example, some operate globally, while others are limited to certain countries, regions or communities, and may take many different corporate forms: ●●

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Commercial banks: Owned by shareholders with (for the most part) the main objective of maximizing shareholder value. Cooperative banks: Owned and controlled by members on the basis of one member one vote, rather than by shareholders in proportion to their shareholdings. Any customer can choose to become a member by investing a small amount of money in the cooperative. Unlike commercial retail banks, however, members of cooperatives cannot sell their stake to a third party and do not have any legal claim on the profits or capital accumulation of the bank. Cumulative profits are owned by the cooperative itself and used to reinvest in the business. Mutuals: Similar to cooperatives, but customers of mutuals automatically become members without having to buy a share. Building societies in the UK are a type of mutual that traditionally focuses on providing mortgages, although they also provide other retail banking products and services. Credit unions: A type of non-profit financial cooperative offering a restricted range of financial services to members within a community that share a ‘common bond’ such as living or working in a particular geographical area, or working for the same organization. These close relationships help them to assess loans and ensure repayment. In some countries credit unions focus on the needs of the most financially marginalized, but in others (for example the United States) they may compete with other types of retail banks for customers. In many countries they play a significant role in improving financial inclusion and other social sustainability goals. Microfinance institutions: These specialize in providing banking services, and in particular credit, to individuals and small businesses that might previously have been excluded from financial services. Although often associated with the developing world, microfinance institutions can be found worldwide. Whilst most microfinance institutions are funded or supported, at least in part, by donors

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seeking to reduce poverty by improving access to financial services, in recent years an increasing number of commercial microfinance institutions have been established to take advantage of growing market opportunities. ●●

Public savings banks: These also have much in common with cooperative banks, but with key differences in ownership and governance. Their ownership structures often reflect a public interest mandate, meaning that they have a dual financial and social mission. Their assets are managed by trustees, often under a stakeholder governance structure. Crucially, however, nobody has ownership rights over ­profits or capital – the capital is in essence ‘unowned’.

QUICK QUESTION How might the different corporate forms outlined above affect how a bank sees its role in relation to environmental and social sustainability?

As retail banks tend (or at least seek) to have close relationships with their individual and small business customers, and in some countries may offer a wide range of financial advice, they play a key role in understanding customers’ evolving needs, expectations and sentiment. Small community banks and credit unions might do this by meeting customers face-to-face; large retail banks utilize ever-increasing sources of customer data to generate insights into emerging preferences and needs. Retail banks (and other organizations offering retail banking services) are well placed, therefore, to identify and respond to changing customer attitudes towards the environment and social sustainability. Retail banks and other organizations providing similar services can also adopt a more active approach, and rather than responding to changing customers preferences can seek to influence customer behaviour. In the context of sustainability, banks can help lead customers towards more sustainable consumption and spending by offering products and services that enable them to track spending and to save, invest and borrow in ways that generate positive environmental and social impacts. Signatories to the PRB and NZBA members need to adopt a pro-active approach in order to meet their commitments to align their strategies, activities and operations with the objectives of the Paris Agreement and the UN SDGs. As we will examine below, both responding to changing customer preferences and seeking to influence customer behaviour has led to the development of a growing range of retail banking products and services to encourage and support more sustainable customer behaviour. The rapidly developing and growing market for

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green and sustainable retail banking products means, however, that the risks of both inadvertent and deliberate greenwashing, examined in earlier chapters, are magnified. In particular, banks and bankers must take care to ensure that, whilst a particular product may support positive environmental and/or social impacts, this should not be used to deflect from environmental or social harms caused by an institution’s other ­activities – especially if these substantially outweigh the benefits.

QUICK QUESTION Think about the bank where you hold your current account, and/or a payment service you use regularly. What, if anything, are they doing to promote environmental and social sustainability through the products and services they offer?

Current accounts, cards and payment services A current account, also known as a checking or demand deposit account, makes funds available to the account owner on demand with immediate access to withdraw cash or make payments. Both personal users and businesses need some sort of current account to manage their day-to-day banking. Some banks offer ‘sustainable’ current account products that enable customers to influence how their deposits are used, as the short Ekobanken case study below describes.

CASE STUDY Ekobanken19 Ekobanken is a small Swedish cooperative bank founded in 1998; it is owned by its members (i.e. depositors) and is a member of the Global Alliance for Banking on Values (GABV). The bank has a mission-led approach to lend funds to support activities that further ecological, social, cultural and economic sustainability, and seeks to attract depositors who want to be able to influence how their money is invested. The bank allows retail clients to choose how their deposits are used. Depositors can either decide that their money is used to support Ekobanken’s general lending, which is focused on firms and activities that create environmental, social or cultural added value, or they can choose specific sectors within these categories where they would like their funds to be invested. Members receive regular information on loans granted. Funds can be earmarked, therefore, for specific lending to, for example,

Responsible retail, commercial and corporate banking

climate mitigation or social care. This would be much more difficult for a larger bank to achieve, as matching depositors’ preferences with lending activities on a large scale would be extremely challenging. Furthermore, Ekobanken offers accounts with or without interest. If they wish, depositors can refrain from collecting interest; this makes it possible for the banks’ clients to receive loans at a lower interest rate. A deposit in Ekobanken therefore gives a two-fold return: an economic return and an impact return.

Credit and debit cards are an important part of the global banking and payments systems, and significantly exceed the value of payments made with cash. The Covid-19 pandemic further accelerated the transition to card and online payments in many countries, although it is important to recognize that the cash payments and services associated with these (e.g. the ability to deposit cash in a bank account) remain important – and often essential – for some individuals, businesses and communities. In recent years, many banks have introduced ‘green’ debit and credit cards that typically offer a small donation to an environmental charity on every purchase, balance transfer or cash advance made by the card owner. In some cases, estimated emissions for purchases made via credit and debit cards can also be offset. The extent to which such cards can be classified as ‘green’ is subject to debate, however. Whilst they may provide a small environmental benefit via donations, cards may also incentivize the consumption of high-carbon goods and services (e.g. air travel, petrol and diesel), and so overall may cause more harm than good. To overcome this drawback, some banks and providers have developed credit and debit cards that can link purchases and emissions. By reporting the greenhouse gas emissions generated by purchases to card holders, this may overcome the tendency of cards to promote unsustainable consumption. One such card, issued by the Swiss Cornèr Bank, is described in the short case study below.

CASE STUDY Climate Credit Card20 The Cornèr Bank/South Pole Climate Credit Card enables users to track both their spending and the environmental impact of their purchases. In addition, CO2 emissions from spending are calculated and offset. There are two types of card available: one for business use and one for private clients. The more often the card is used for business or personal purchases and services, the greater the amount of harmful global emissions that can be offset.

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The Climate Credit Card offers: ●● ●●

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automatic capture and calculation of CO2 emissions of all purchases on the card; a monthly statement of expenses and an annual statement of CO2 emissions generated; offsetting of emissions through emissions reduction projects, at no additional cost to the cardholder.

According to South Pole, who developed the cards for Cornèr Bank, these will help individuals and corporate users make more sustainable consumption choices and purchases.

Current accounts, and the payment cards linked to these, are increasingly accessed online and/or via mobile banking apps, which enable customers to manage their everyday banking activities via smartphones and other devices. The use of digital finance (‘FinTech’) tools and techniques enables banks and others to offer products and services that integrate environmental and other sustainability data to help customers make and support more sustainable consumption choices (e.g. carbon footprint trackers linked to banking apps), as we will see below and examine in Chapter 11, which looks at the use of digital finance and FinTech to support and grow green and sustainable finance in more detail. The growth of digital finance and FinTech, particularly in developing banking markets including in Africa and China, has seen ‘traditional’ current account banking replaced and/or supplemented by online and mobile payment services. Amongst the best known of these are Alipay, PayPal and M-Pesa, the latter a mobile phonebased money transfer service operating in several African countries, India and the Balkans. M-Pesa has played a key role in the countries where it operates in significantly enhancing financial inclusion, giving many millions of individuals, families, farmers and businesses access to payment services, lending and insurance that they had previously been unable to benefit from. Using digital payment apps and similar products to promote more sustainable consumption choices and/or offset emissions from purchases is another area of rapid development. A leading example is Ant Forest, part of Alipay, the world’s largest online and mobile payment provider and part of the Ant Financial Services Group,

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one of the largest financial services firms in the world, based in China. The size of their user base enables Alipay and similar large payment services providers to understand and shape consumer behaviour in many respects, including in the area of green and sustainable finance, as the following case study demonstrates.

CASE STUDY Ant Forest21 Launched in 2016, Ant Forest (China) is a personal carbon account hosted on Alipay, the world’s most popular payment app, which has more than 1 billion users. It is designed to encourage users to reduce their personal carbon footprint, and more generally to consider the impact of their activities and purchases on the environment. It combines behavioural ‘nudges’ for Alipay users with gamification and satellite monitoring to change consumer behaviour, reduce carbon emissions and increase reforestation. Ant Forest offers 16 different ways users can reduce their carbon footprint, including by using public transport, paying bills online and cutting down on their use of paper at home and at work, all tracked through Alipay. Users claim carbon points for their activity and save these to their personal carbon account. Carbon points are converted into virtual ‘green energy’ which is used to water and grow virtual saplings in the Ant Forest app; gamification encourages users to compete to grow their virtual saplings and share their progress with family, friends and others. When enough ‘green energy’ has been accrued to grow a virtual tree, this is converted into the planting of a real tree. Some of the planting is monitored via satellite and drone, allowing Ant Forest users to see the progress and results of tree planting in desert regions in Inner Mongolia, for example. The size and scale of the Alipay payment platform enables Ant Forest to have a significant impact on consumer behaviour and carbon emissions, with some 500 million users of the Ant Forest app as of August 2019: ●●

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A total reduction in carbon emissions of 1.22 million tonnes CO2e was achieved in the first year of Ant Forest’s operation. More than 120 million real trees had been planted by Ant Forest by August 2019, covering more than 100,000 hectares.

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Banks such as the Bank of Åland (Finland), Nordea (Sweden) and NatWest (UK) have launched CO2 trackers linked to their mobile and digital banking apps, helping customers see the impact of their consumption decisions on their carbon footprints, as described in the case study in Chapter 11. Carbon footprint trackers such as these help incentivize more sustainable consumption decisions and promote behavioural change both by providing real-time (or close to real-time) information to inform decision making, and also through gamification that encourages users to reduce their carbon footprint month by month and compare their progress with friends and family. Some CO2 trackers also provide a facility for customers to offset their carbon emissions. For retail banks, integrating a carbon footprint tracker into mobile banking apps helps them build stronger and stickier customer propositions, and encourages the use of the bank’s app(s) and payment services, rather than those of competitors.

Savings products Retail banks – and other providers offering retail banking services – typically offer customers a range of savings accounts and products that pay a higher rate of interest than on-demand current accounts, though customers typically do not have immediate access to the money they invest in savings products. Savings products include investment accounts, term deposit accounts and savings bonds. In many countries, retail savings products attract tax benefits to incentivize household saving. Some banks offer green and sustainable savings products that enable customers to direct their savings towards environmentally and socially sustainable lending and investment. These may be products that contribute towards the financing of sustainable projects or businesses directly, or products that invest savings in investment funds with a green and/or sustainable focus, as described in the four short case studies below.

QUICK QUESTION Which of the products/approaches below do you think is the most embedded in terms of aligning a bank’s activities with sustainability? Why?

CASE STUDY CIMB EcoSave savings account22 Commerce International Merchant Bankers Berhad (CIMB) is a large Malaysianbased bank operating in 18 countries in Malaysia and the ASEAN region. It offers both regular and Islamic banking services.

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The EcoSave account – considered to be the first environmentally focused savings account in Malaysia – is a Shariah-compliant savings account that enables savers to invest funds to earn a profit (Islamic savings products do not pay interest, but the profit share is a similar concept that rewards savers with profit rates of between 0.15 per cent and 1 per cent per annum). There is a minimum deposit of RM 250, and customers who maintain an average monthly balance of RM 5,000 receive a monthly cash incentive of RM 5. The account’s environmental benefits come in two forms: ●●

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Unlike competing savings products, the account is completely paperless (no passbooks, physical bank statements or customer mailings – a monthly e-newsletter on CIMB’s environmental activities is distributed electronically). 0.2 per cent of the total EcoSave average portfolio balance is contributed by CIMB to support a range of environmental activities, including reforestation and the sustainable management of wetlands.

In 2020, for example, CIMB committed RM 1 million (approximately $250,000) per year for three years to support conservation efforts in the Setiu Wetlands, in partnership with WWF Malaysia.

CASE STUDY YES BANK Green Future Deposit Certificates23 On World Environment Day in June 2018, India’s fourth-largest private sector bank, YES BANK, launched its innovative ‘Green Future Deposit’ savings product. The 18-month, fixed-term deposit scheme offers high rates of interest (up to 7.5 per cent p.a. and up to 8 per cent for senior citizens), and allocates the funds raised to invest in projects and sectors aligned with the UN Sustainable Development Goals (SDGs). Recognizing its leadership in India in green and sustainable finance, in November 2019 YES BANK was approved as an accredited entity by the UNFCCC-led Green Climate Fund, established to support developing nations in responding to climate change. As an accredited entity, the bank will develop and implement climate change mitigation and adaptation projects funded by the Green Climate Fund. YES BANK was also one of the founding members of the UN Principles for Responsible Banking, and the only Indian bank amongst these.

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YES BANK aligns its strategies, activities and products and services more broadly with the UN SDGs through the ‘Circle of Goodness’, incorporating a range of initiatives to create positive environmental and social impact: ●● ●●

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funding measures to address biodiversity loss and promote conservation; providing clean and safe drinking water at railway stations and other locations across India; funding and providing advice to Indian SMEs on improving energy efficiency and environmental sustainability; conducting climate literacy workshops to raise awareness of climate change and related issues.

CASE STUDY Green ISAs in the UK In the UK, an ISA (individual savings account) is a savings account that enables individuals to save or invest money – currently up to £20,000 per year – without paying tax on the interest or on the capital gains received. Some banks and other financial institutions offer ISAs that invest in green and environmentally sustainable areas. As with other investments labelled ‘green’ or ‘sustainable’, care needs to be taken by investors and advisers to ensure that the component parts of these are genuinely sustainable. Examples of genuinely green and sustainable ISAs in the UK include: Ecology Building Society Cash ISA24 The Ecology Cash ISA enables individuals to save in a straightforward, no-notice savings account. The main difference between the Ecology Cash ISA and similar Cash ISAs and other savings products offered by mainstream banks is that the deposits received are used to fund mortgages for projects that make a positive environmental and/or social impact. In 2020, the Ecology Building Society lent nearly £40 million to support 230 sustainable properties and projects. Abundance Innovative ISA25 The Abundance Innovative ISA takes advantage of a new type of ISA introduced by the UK Government in 2016 to encourage peer-to-peer and other alternative forms of lending. Abundance is not a bank, but by offering peer-to-peer lending in the form of the Innovative ISA, it performs one of the key functions of a bank – the provision of

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credit. The Abundance Innovative ISA provides savers with a choice of investments in companies and councils (municipalities) undertaking climate change mitigation and adaptation activities. Investments include renewable energy projects such as wind, solar and marine, and other projects focused on social sustainability. Investors can choose the projects that appeal to them most, and build their own portfolios to match their financial and sustainability preferences. In the first year of the Green ISA’s operation (2016–17), Abundance attracted more than 1,400 investors with a total investment of £10.5 million. By 2020, a total of 46 projects had been funded with more than £100 million invested. Many of the investments offer relatively high returns of 10 per cent to 12 per cent; this reflects the higher risks involved, however, and whilst investments are vetted by Abundance, the risk of impairment or default is higher than for many traditional ISAs.

CASE STUDY UBank Green Term Deposits26 UBank is the ‘direct banking’ (i.e. accessible online and via telephone only) subsidiary of National Australia Bank. In 2019, UBank launched a small range of Green Term Deposits, described as the ‘world’s first consumer Green Term Deposit certified by the Climate Bonds Initiative’; it targets depositors seeking to align their savings with environmentally positive outcomes, a growing segment in Australia. With a minimum deposit of AU$1,000 (approximately $700) and term options of between two and 11 months, interest rates on Green Term Deposits are similar to UBank’s other term deposit products. When a saver invests funds in a Green Term Deposit, though, NAB earmarks these funds for environmentally sustainable lending by holding at least an equal amount in a pool of lending for projects and assets that will be certified under the Climate Bonds Standard (introduced in the following chapter, but in brief this ensures lending is used for genuinely environmentally sustainable purposes).

Green and retrofit mortgages Residential homes account for a substantial proportion of CO2 emissions. Direct and indirect emissions from buildings were estimated as 23 per cent of total UK emissions in 2019, with residential buildings accounting for more than three-quarters of this, according to the UK Climate Change Committee.27 The IPCC reported that

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residential buildings accounted for some 24 per cent of global energy use in 2010.28 For many national and regional governments, cutting emissions from housing is seen as a key priority to help them meet national and international commitments to reduce emissions, with building codes and other legislation/regulation being updated to reflect this. ‘Green mortgages’, a term used mainly to refer to mortgages on new, energy-efficient homes, are one way of incentivizing the purchase of lower-emission homes, and have been launched in recent years in countries including the US, UK, Sweden, the Netherlands and Australia. They are an example of the ‘green tagging’ of loans, whereby the terms of the loan are linked to the underlying asset’s energy performance, fuel efficiency or environmental standards. In general, green mortgages offer borrowers below-market interest rates for purchasing new, energy-efficient homes, as described in the Barclays Green Mortgages case study below. In general, green mortgages are offered at slightly lower interest rates than conventional mortgages in order to reflect the lower risk profile of green mortgage customers and/or the presence of government incentives. There is some evidence from the US,29 UK30 and the Netherlands31 that owners of more energy-efficient homes are less likely to default on their mortgage payments, justifying a lower rate of interest. This might be because energy efficiency lowers energy use, energy-efficient homes have lower utility bills, and homeowners should therefore have higher levels of disposable income with which to service their mortgages. Of course, it might also be that purchasers of energy-efficient homes are more likely to have higher disposable income to begin with and are less likely to default on their mortgage payments overall.

CASE STUDY Barclays Green Mortgages32 In 2018, Barclays launched the UK’s first Green Mortgage for purchasers of new, energy-efficient homes. The original scheme was successfully trialled with a small group of housebuilders, so now Barclays Green Mortgages are available to customers purchasing any newbuild home from a builder or developer with an Energy Performance Certification (EPC) rating of A or B. Green Mortgages are available for fixed terms of two or five years, and for up to 90 per cent loan to value (LTV). In 2022, the bank launched a similar range of Green Mortgages for small buy-to-let investors, for up to 75 per cent LTV. Homeowners benefit from preferential interest rates – a 0.1 per cent discount compared with the standard Barclays mortgage products. At launch, the bank claimed that the discounted interest rate plus the energy savings from a more efficient home could save a typical three-bedroom UK household £1,335 over five years.

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Using data on mortgage defaults from the US and the UK showing that owners of energy-efficient homes are less likely to default, the lower credit risk for green mortgages means that Barclays can still make an acceptable return despite the discounted interest rate. In addition, some of the proceeds of Barclays’ 2017 green bond issues are being used to support the development of its green mortgages, in addition to refinancing low-carbon residential properties more generally, in England and Wales. Having pioneered the market for green mortgages in the UK, Barclays have inspired other lenders to follow suit, and as of 2022 there are nearly 40 green mortgages now available in the UK, according to the Green Finance Institute.

In many countries, some of the greatest climate change mitigation benefits (in terms of reducing greenhouse gas emissions from residential sources) will come from increasing the energy efficiency of existing housing stock through improving glazing and insulation and replacing oil and gas-fired boilers with heating powered by renewable-generated electricity, hydrogen or ground source heat exchangers. Some lenders, therefore, offer green mortgages that incentivize energy efficiency improvements in existing properties, known as ‘retrofit mortgages’. The UK’s Ecology Building Society, for example, offers a ‘C-Change Discount’ that rewards borrowers with interest rates reduced by up to 1.5 per cent when energy efficiency improvements are made.33 From a technical perspective, most older properties can be retrofitted to improve energy efficiency, but it is expensive to do so in terms of the upfront capital costs of replacing gas central heating with hydrogen or heat pumps. Significant annual savings in energy costs should accrue over the long term, however, supporting mortgage or loan repayments, and generating returns for both lenders and borrowers, as well as ­environmental benefits. A similar model – financing higher capital expenditure to be repaid though lower operating expenditure – supports many aspects of green lending, whether on the retail side as in mortgages, or in corporate banking in lending to finance the construction and operation of renewable energy generation such as wind farms or solar farms. The UK’s Green Finance Institute has established the Coalition for the Energy Efficiency of Buildings (CEEB) to develop the market for, and financial products and services to support, the retrofitting of residential buildings. In 2020, the Institute published the Green Home Finance Principles, which provides a consistent methodology for the financing of residential retrofitting works.34 These are similar in many respects to the Green Bond and Green Loan Principles described elsewhere in this book, with core components requiring the transparent disclosure of the use and management of proceeds, project selection and reporting.

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Whilst the term ‘green mortgage’ is becoming more popular, and seems to resonate with potential customers, banks may also integrate aspects of a green mortgage into more traditional mortgage lending. A property’s current energy efficiency and/or plans to improve energy efficiency might be factored into affordability calculations, for instance, enabling a lender to offer a higher overall sum or loan-to-value ratio (or, as in the case of the C-Change Discount described above, a lower interest rate).

CASE STUDY European Energy Efficiency Mortgage35 The European Energy Efficient Mortgage Initiative brings together a consortium led by the European Mortgage Federation (EMF) and funded by the EU’s Horizon 2020 Programme to develop a standardized energy-efficient mortgage based on preferential interest rates for energy-efficient homes and renovations resulting in improved energy efficiency. The initiative is premised on the belief that mortgage lenders ‘can play a game-changing role in providing long-term financing for energy improvements to the existing European housing stock’. The underlying concept is that mortgage lenders in the EU will offer households the possibility of a preferential interest rate and/or additional funds at the time of origination of the mortgage/re-mortgage in return for making energy-efficient improvements to the property. A standardized approach to the provision of mortgage financing for energyefficient investment will also ensure the ultimate ‘pricing-in’ of the added value triggered by improvement measures. The proposed mechanism rests on two key assumptions regarding the market characteristics that will be tested by the initiative: 1 Retrofitting impacts positively on property value, ensuring wealth conservation and loss mitigation by preventing ‘brown discount’. 2 Energy efficiency leads to a reduction in the impact of energy costs on income, reducing the borrowers’ probability of default. The consortium includes the World Green Building Council, RICS, E.ON, the University of Ca’ Foscari (Venice), Goethe University (Frankfurt) and a number of leading banks across Europe, who will be piloting the scheme and working to substantiate the correlation between a property’s energy rating and the financial performance of the mortgage.

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As well as offering green mortgages and other loans to support improvements in residential buildings’ energy efficiency, lenders need to monitor and report the environmental impacts of their lending to ensure it is creating the intended reductions in greenhouse gas emissions. In Chapter 4, we introduced the Partnership for Carbon Accounting Financials (PCAF), which provides a standardized methodology for financial services firms to track Scope 3 financed emissions. Residential mortgages are one of the six asset classes PCAF currently supports, and financial institutions are strongly recommended to implement PCAF to track their progress in reducing financed emissions from mortgage lending. According to Kees van Dijkhuizen, CEO of Dutch bank ABN AMRO: Our experience in the Netherlands is that measuring and tracking climate impact drives concrete action and change. [...] PCAF helped us understand that our nearly 800,000 residential mortgages are one of the areas that have the highest carbon impact. With that knowledge, we now promote mortgages that incentivize customers to take energy efficiency measures. Climate action like that is not only good for business – but is a duty to our clients, the planet, and to future generations.36

Electric vehicle financing Globally, transport contributes more than 25 per cent of global greenhouse gas emissions, with the world’s 700 million road vehicles, together with vehicle manufacturing, estimated to be responsible for some three-quarters of this.37 It is expected that global car ownership will triple by 2050, and so incentivizing the purchase or leasing of environmentally friendly vehicles is crucial for reducing greenhouse gas emissions. One way that the banking sector can help to do this is by offering green electric vehicle loans and other forms of finance (e.g. electric vehicle leasing) usually available to both individual and business customers. Loan pricing that varies according to emissions, and loans that offset emissions from petrol and diesel vehicles, are also available. Green car loans are another example of ‘green tagging’, whereby customers are incentivized to purchase low- or zero-emission vehicles at below-market interest rates. Lower interest rates reflect the lower risk profile of green car loans (as borrowers will have lower operating costs and electric or hybrid vehicles have higher resale values) and/or the presence of government incentives to support the purchase of (usually) more expensive electric vehicles. As with mortgages and loans to fund home energy efficiency improvements as described above, this is an instance of a lender financing higher capital expenditure that can be repaid though lower ongoing costs and operating expenditure.

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CASE STUDY Bank Australia38 Bank Australia links all car loans to the environmental impact of the vehicle being purchased, both for petrol and diesel vehicles and for low/zero-emissions vehicles. The latter qualify for lower interest rates (with a discount of approximately 1 per cent compared with loans for petrol and diesel vehicles). Interest rates vary, however, depending on the type of vehicle and its emissions. Bank Australia also commits to offsetting 100 per cent of a vehicle’s CO2 emissions for the term of the customer’s loan by purchasing carbon offsets eligible under the Australian National Carbon Offset Standard (NCOS).

CASE STUDY Energy Saving Trust39 Funded by Transport Scotland (a Scottish government agency), the Energy Saving Trust can help you purchase a new electric car. Drivers in Scotland can benefit from zero-interest, six-year loans of: ●●

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up to £28,000 to cover the cost of purchasing a new ‘pure’ electric vehicle (i.e. not including hybrids); up to £10,000 to cover the cost of purchasing a new electric motorcycle or scooter.

Similar loans of up to £20,000 for second-hand pure electric vehicles are also available, with a repayment period of five years.

As the popularity of electric vehicles grows, financial services firms and others are offering a variety of leasing and subscription services where an electric vehicle is leased or hired for a long-term period, rather than acquired and owned. These services usually encompass the costs of maintenance, insurance, breakdown cover and other ownership costs, all covered via the payment of a single monthly fee. For potential purchasers, the high upfront costs of an electric vehicle are avoided, although the monthly subscription cost is likely to be substantially higher than the operating costs of the vehicle were it purchased, even when the additional costs of ownership are

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factored in. In addition, as the vehicle is not owned, it cannot be sold second-hand, and therefore has no residual value for the user. The high upfront costs of purchasing electric vehicles creates barriers to their adoption, particularly by those on lower incomes in both the developed and developing world. Loans and other financial products and services that facilitate the ownership and use of electric vehicles can therefore play a role in a just transition, ensuring that the benefits of electric vehicles are widely shared.

Small and micro business lending Bank lending (and other forms such as peer-to-peer lending) to small and micro businesses is a key driver of economic growth in both developed and developing markets. How ‘small’ and ‘micro’ businesses are defined differs between countries and regions, but in general we may consider ‘micro’ businesses as employing fewer than five people, and ‘small’ businesses to be larger than this. Loans may be used by entrepreneurs and their businesses for a wide variety of purposes, including, but not limited to, providing working capital, buying stock or new equipment, leasing business premises, expanding into new segments and markets, and recruiting additional employees or contractors. Loans may be secured, that is, the borrower pledges assets as collateral, which the lender may sell to recoup some or all of the sum borrowed in the event of default, or they may be unsecured, where there is no such collateral pledged; such loans are therefore riskier and tend to incur higher interest rates. ‘Green’ lending to small and micro businesses may take a variety of forms, but generally offers more favourable terms (for example, lower interest rates or more relaxed collateral requirements) for loans with a clearly defined purpose of having positive environmental outcomes, such as investing in more energy-efficient or otherwise more sustainable production equipment or premises. The demand for green loans may be driven, in some cases, by developments in regulation, particularly around energy efficiency, for example, where building codes require energy efficiency improvements. There is also substantial demand, particularly in developing markets, for green lending in the agricultural sector, where farmers and smallholders may comprise a substantial part of the economy and are key stakeholders in climate change mitigation and adaptation efforts. In developed markets, banks and other financial institutions may offer a range of green and/or sustainable finance loans. One example is global bank HSBC, which has set up a dedicated unit to invest in CleanTech innovation.40 Other examples are Lloyds Banking Group’s ‘Clean Growth Finance’ initiative41 and Nordea’s green ­lending scheme, described in the following case study.

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CASE STUDY Nordea Bank’s Green Lending Scheme42 Nordea is offering green financing to small and medium-sized corporates in the Nordic countries – financing that promotes sustainable investments, which means that small and medium-sized corporate customers will be able to level up their sustainability work. Green bonds have been available for some time, especially for large real estate companies, but since July 2018 Nordea – as the first player in the market – has also offered green financing to small and medium-sized companies in several different industries. ‘We have over half a million small and medium-sized corporations as customers. We are in constant dialogue with our customers and sustainability is a topic that is often raised. This indicates that the demand for products such as green loans is high and will continue to increase,’ says Anders Langworth, Nordea’s Head of Group Sustainable Finance. The whole value chain is sustainable; the product is based on green market funding, and the customer commits to using the financing for a sustainable investment, which requires them to report the positive impact of the investment on power or water consumption, for example. This means that both the investment and financing will be sustainable. Examples of sustainable investments are energyefficient buildings, wind power, pure water treatment and solar power. Customers who qualify for green financing will also get slightly more favourable commercial terms compared with non-sustainable financing. Positive environmental impact This type of green loan can have a positive impact on the environment. When it comes to real estate, buildings must be at least 25 per cent more energy efficient than the Swedish building regulations for new buildings. Nordea will also provide financing for investments in renewable energy, which have an even stronger positive effect on reducing emissions. ‘We believe that green financing is here to stay and will be established as a market standard in the future. We do also believe that our own credit portfolio will grow stronger since the most sustainable companies are the winners of tomorrow – something studies already show,’ says Anders Langworth.

In developing countries (and in some developed countries, too) microfinance lending plays a key role in promoting green and sustainable development. Individuals, smallholders, farmers and microbusinesses in developing countries may engage in agriculture, aquaculture or forestry that damages the environment. Microfinance lenders

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can support sustainable practices, such as reducing water usage or c­ hemical-based fertilizers, by providing green microloans and other financial services to individuals and microbusinesses where the loans are linked to achieving environmentally positive outcomes. In some cases, lenders offer additional services to their clients, such as education and training, to promote the adoption of more sustainable approaches. New approaches are being developed to stimulate the growth of green and sustainable lending. In Kenya, for example, the Climate Smart Lending Platform, developed by F3 Life, is designed to reduce credit default risk and improve lender profitability (and hence lenders’ desire and ability to lend) in agricultural lending to smallholders. As well as benefiting microfinance lenders, the scheme is also designed to promote the adoption of more sustainable farming practices which sequester carbon into farm soils and enhance resilience to climate change and extreme weather events. This is a good example of how a combination of ‘traditional’ banking skills (credit assessment) with FinTech tools and techniques can support farmers who might otherwise struggle to access affordable credit, providing a commercial return while supporting climate change mitigation and adaptation activities, as well as broader sustainability goals.

CASE STUDY Climate-Smart Lending Platform43 The ‘Climate-Smart Lending Platform’, trialled in Kenya in 2019, integrates with agrilenders’ core banking systems and credit scoring processes. Through partners, the Platform reduces the costs and complexity of client onboarding, whilst the use of technology reduces credit default risk, particularly from extreme weather events, and promotes positive environmental outcomes by supporting climate-smart farming practices and land use decisions: ●●

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Step 1: Farmer signs a loan and land management agreement The loan terms and conditions are designed to incentivize farmers’ use of climate-positive agricultural and land-management practices, and may include preferential loan terms for women. Step 2: Loan repayment and environmental restoration The farmer repays the loan and implements the required climate-smart and sustainable agricultural and land management practice. Step 3: Monitoring Mobile technology is used to monitor the implementation of climate-positive agricultural and land management practices, and the data is passed back to lenders.

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Step 4: Climate-smart credit scoring When a farmer complies with the climate-smart requirements of their loan agreement, they are provided with a new score that boosts their initial credit score.

In the next section of this chapter we look at green and sustainable commercial and corporate lending on a larger scale, describe the Green Loan Principles and introduce the recently published Sustainability Linked and Social Loan Principles. In many developing countries, green lending, and other lending – by established banks, microfinance institutions and/or other traditional and non-traditional lenders designed to support a wider range of sustainable goals including financial inclusion and gender equality – is often supported by national or multilateral development banks (see Chapter 8), development charities and/or other impact investors. This is because the capital required and the risk/return profile may not be attractive to commercial lenders. This is beginning to change, however – particularly as the introduction of FinTech tools and techniques (see Chapter 11) makes it easier and more cost-effective to provide lending and other financial services to previously unbanked individuals and communities, as the following short case study demonstrates.

CASE STUDY hiveonline44 A good example of the use of FinTech tools and techniques to support microfinance lending for unbanked communities is hiveonline. Founded in Niger by Sofie Blakstad, and part of the ‘humanitarian blockchain’ movement, hiveonline is a banking platform that provides a credit history for 350+ million unbanked individuals, smallholders and SMEs. It builds financial resilience, removes opportunities for corruption and fosters cash-free financial ecosystems. Designed for locations with poor internet connectivity and little penetration of smartphones, it helps bring remote villages out of poverty through the provision of finance. hiveonline works with local savings groups, often comprised of women and microfinance lenders. Groups record their savings and lending transactions on the blockchain, but to reduce the need for technology the system is configured so that every member of a savings group can have a personal identity and digital history using just one smartphone or other device per group. As transactions are built up and recorded, savings groups build reputation and creditworthiness by creating a

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digital record of commitments made and met, including lending and repayments at both the group and individual member levels. hiveonline reports that group default rates are low – typically less than 2 per cent – so lenders can reach reliable customers while groups and their members can access the lending they need to grow their small businesses.

Corporate and investment banking products and services Introduction to corporate and investment banking Corporate and investment banking (also known as ‘wholesale banking’) refers to the provision of products and services by a bank to large corporate and institutional clients, and other financial institutions, rather than to individual customers and SMEs. Corporate banks provide banking products to large organizations that often have more complex financing needs than smaller firms. This includes deposit and treasury facilities, corporate loans to finance investment, project finance for large infrastructure or industrial projects and trade finance to help companies buy and sell in global markets. Investment banks help companies raise debt and equity finance in national and international capital markets by issuing and underwriting bonds and shares. We examine green and other forms of sustainable bonds in the next chapter, and equity markets in Chapter 9. Investment banks also trade bonds, shares and other financial instruments on behalf of their clients and for themselves (known as ‘proprietary ­trading’), and offer a range of research and other advisory services.

QUICK QUESTION How might corporate and investment banks support the transition towards a more sustainable economy?

Bank loans are the main source of funding for corporations globally. Whether bank lending is used to support environmentally and socially sustainable activities and technologies and/or organizations’ transitions to more sustainable business models, or – by contrast – activities that harm the environment and society, is therefore of great importance in aligning finance with the objectives of the Paris Agreement and other sustainability goals.

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Global green lending has grown rapidly in recent years, according to TheCityUK, from approximately $430 million in 2017 (the first year for which comprehensive data is available) to nearly $80 billion in 2021.45 Despite significant growth, however, lending to support green and sustainable sectors, firms and activities is substantially outweighed by continued lending to high-carbon sectors and firms, as we noted in Chapter 1 and earlier in this chapter. Even on the broadest definition, ‘green lending’ accounts for less than 5 per cent of total global bank lending. Corporate and investment banks therefore have an important role to play – but need to do much more – in decarbonizing their lending portfolios and mobilizing private capital to support lending to environmentally and socially sustainable activities.

Green and sustainable corporate lending The greening of corporate lending (generally speaking, lending to businesses larger than the small and micro businesses described above) takes several different forms, as we will explore in this section. The first generally recognized ‘green loan’ (aligned with the Green Bond Principles) was arranged by Lloyds Banking Group and Rabobank for UK retailer Sainsbury’s in 2014. This was for a £200 million facility to finance renewables, energy efficiency, water use management and carbon reduction. In April 2017, ING issued the world’s first sustainability-linked loan (SLL) to Dutch multinational Philips, linking the interest rate of the €1 billion loan to the company’s sustainability performance.

Green and social loan principles Following the signing of the Paris Agreement in 2015, many banks have developed ‘green lending’ and similar programmes to offer ‘green loans’ to corporate clients. Such programmes generally support investment in energy efficiency improvements, the purchase of low-carbon assets and technologies, and other climate change mitigation and resilience projects and activities, as exemplified in the case study below.

CASE STUDY GBTI Bank green loans46 GBTI Bank has launched a range of green loans providing financing for products, businesses, projects and home and office improvements that promote ‘low carbon’ emissions. Eligible categories include: ●●

solar energy products

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water treatment, water recycling, water filters

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hybrid motor vehicles

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energy-saving appliances

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air filters

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wind-powered projects

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hand-powered projects

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low-carbon economic investments, such as high-end fruits and vegetables, aquaculture

Benefits to clients include: ●●

competitive interest rates

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fast approvals

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25 per cent discount on lending services

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one to six months’ moratorium on payment of instalments, where applicable

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no late payment fees or prepayment penalties

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a low equity contribution of 10 per cent

The green loans initiative was driven by Guyana’s Low Carbon Development Strategy (LCDS), and GBTI’s desire to: ●● ●●

promote non-pollution to improve our ecological systems; promote energy conservation through the use of energy-saving appliances and methodologies;

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facilitate investment and employment in low-carbon sectors and new enterprises;

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contribute to the economic value of the country;

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maintain ecological systems and good business practices;

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help secure a healthy planet for future generations.

As well as offering green loans, GBTI Bank also supports sustainable development more broadly, via: ●●

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Rupununi Ventures – a collaborative partnership between GBTI, Conservation International and the Inter-American Development Bank (IDB), supporting community-based activities in a rural area of Guyana, while preserving natural capital. Small Business Bureau Loans – credit of up to $30m for micro and small businesses in low-carbon sectors at a low rate of 6 per cent per annum, supported by the Guyana Ministry of Business and the IDB funding.

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QUICK QUESTION How can banks (lenders), borrowers and others assess whether a loan is genuinely ‘green’ or not?

Green lending is difficult to track, however, as there is no universally accepted definition of what comprises a ‘green loan’. This is problematic, as without a common understanding of which loans are genuinely environmentally sustainable – and which are not – tracking flows of green and sustainable finance is challenging, and instances of inadvertent or deliberate greenwashing may occur. Linking ‘green loans’ to economic activities classified as sustainable in the EU and other taxonomies and similar frameworks can help, but this raises issues of comparability (and potential arbitrage) where there are differences between these. To bring consistency to the green loan market, therefore, the Green Loan Principles were published in 2018; they include a definition which seems set to become the generally accepted market standard: Green loans are any type of loan instrument made available exclusively to finance or re-finance, in whole or in part, new and/or existing eligible Green Projects… Green loans must align with the four core components of the Green Loan Principles.47

Green Loan Principles In March 2018, the Loan Market Association (LMA), a large group of banks, investors and professional services firms active in in Europe, the Middle East and Africa, together with the Asia Pacific Loan Market Association (APLMA) and the International Capital Markets Association (ICMA), launched the Green Loan Principles (GLP). A revised, updated version was published in February 2021.48 These are based on a similar approach pioneered in the Green Bond Principles (GBP), which we cover in more detail in the next chapter. The GLP provide a voluntary framework and standards for ‘green’ lending by institutions, and are designed to promote global consistency in the application and reporting of green loans. They aim to ensure consistency in the use of the term ‘green loan’, to maintain the integrity of the green loan market, and to avoid instances and accusations of greenwashing. Although voluntary, the Principles are endorsed by a wide range of institutions and seem likely, as has been the case with the Green Bond Principles, to become generally accepted as market standards and

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encouraged, if not formally endorsed, by key regulatory and policymaking bodies. The Principles were developed primarily for the syndicated loan market (where a group of lenders pool funds to finance a large loan for a borrower). They have broad applicability and are being increasingly referenced across many types of corporate lending. Under the Green Loan Principles, lenders and their advisers are expected to apply the four key components summarized below on a deal-by-deal basis, with some flexibility allowed to account for the many different types of loans and their uses: 1 Use of proceeds Green loan proceeds should be utilized for ‘green projects’ – the GLP provide a list of indicative eligible project categories (for example, renewable energy, clean transport, climate change adaptation). Projects should have clear environmental benefits and, where possible, these should be quantified, measured and reported by the borrower. The use of proceeds should be transparently disclosed in the loan documentation and marketing materials. Recognizing that a green loan may take the form of one or more tranches of a loan facility, green tranches must be clearly designated, with proceeds credited to a separate account or tracked by the borrower in an appropriate manner. 2 Process for project evaluation and selection Borrowers should clearly communicate their environmental sustainability objectives, how proposed projects fit within the GLP’s eligible categories and should disclose any material environmental risks to lenders. Borrowers are encouraged to position this information within their general business aims, objectives, strategies, policies and processes. They should also disclose any relevant environmental standards or certifications to which they are seeking to conform. 3 Management of proceeds Proceeds from a green loan should be credited to a dedicated account or otherwise tracked by borrowers in an appropriate way so as to maintain transparency and promote the integrity of the green loan market. Borrowers are encouraged to establish an appropriate internal governance process through which they can track the allocation of funds. 4 Reporting Borrowers should make and keep readily available up-to-date information on the use of proceeds, to be renewed annually until a loan is fully drawn, and as necessary thereafter in the event of material developments. This should include a list of the Green Projects to which the green loan proceeds have been allocated, and a

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description of the projects, the amounts allocated and their expected impact. The use of qualitative and quantitative performance indicators to demonstrate impact is recommended, together with transparent disclosure of the approaches and methodologies employed to assess impact and outcomes. Currently, the GLPs recommend an independent review of green loans, but this is not required. Such reviews may be performed by independent consultants or agencies, who may formally certify against external, green assessment standards or verify claims made and/or internal standards. The Principles also recognize self-certification by borrowers where, in the opinion of the lender, they have the relevant expertise. Over time, as the Principles become more widely used and embedded, it is likely that third-party assurance and verification will become the norm (as is the case in the green bond market) to enhance consistency and integrity. The LMA have published guidance to support the application of the GLPs, with the aim of clarifying definitions and harmonizing approaches.49 In addition, the LMA have developed a Sustainable Lending Glossary of Terms related to green lending, and sustainable lending more broadly, to further enhance consistency in market participants’ use of terminology.50 An increasing range of sectoral guidance is also available from the LMA; for more information, please see www.lma.eu.com/ sustainable-lending

CASE STUDY Macquarie Group and Asia-Pacific’s first labelled green loan51 In June 2018, Australian financial group Macquarie issued the first recognized green loan under the Green Loan Principles published by the Asia Pacific Loan Market Association (APLMA). A £500 million ‘green tranche’ drawn from 19 financial institutions formed part of a wider £2.1 billon syndicated loan facility, with the green tranche divided into two components. The full details can be viewed on page 6 of Macquarie’s Green Finance Impact Report 2020. Use of proceeds Macquarie has developed a Green Finance Framework (GFF) in accordance with the Green Loan Principles and supported by a second opinion external review by Sustainalytics, which sets out project categories that provide clear environmental benefits. These include addressing climate change, natural resources depletion, loss

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of biodiversity, and air, water and soil pollution. Activities and lending to an industry or technology that directly involves fossil fuels, nuclear or biomass suitable for food production are specifically excluded. PwC provides independent assurance on the bank’s compliance with the obligations contained within its GFF. During the reporting period, a total of 13 projects were allocated funding from the green tranches. They concerned the construction and operation of onshore and offshore wind, and solar installations in Australia, Japan, Malaysia, Poland, Sweden and Taiwan. According to Macquarie’s Green Finance Impact Report, the portfolio of 13 projects will provide over 8,000 GWh of renewable energy generation per year (sufficient to power 1.9 million households) and will avoid greenhouse gas emissions of 3,461kt CO2e per year (equivalent to taking 1.1 million cars off the road). Process for project evaluation and selection Macquarie has established a Green Finance Working Group (GFWG) with responsibility for governing and implementing the GFF. The GFWG comprises representatives from the Environmental and Social Risk (ESR) team and the Green Investment Ratings team, with in-house environmental expertise, as well as representatives from Macquarie’s Credit Risk Management Group, Group Treasury and Macquarie Capital. Business units will identify potential eligible projects based on the criteria in the GFF’s use of proceeds. Such projects are submitted to the GFWG for review and confirmation that they qualify under the GFF. This includes the preparation of a suitable Green Opinion provided by the Green Investment Ratings team, where appropriate, confirming that a project: a falls within one of the eligible project categories defined in the GFF; and b is anticipated to provide clear environmental sustainability and/or climate change mitigation benefits. Management of proceeds The proceeds of green tranches are not credited to a dedicated account, but are deposited in Macquarie’s general funding accounts. The bank has developed an internal governance process to notionally allocate proceeds against eligible projects in an appropriate manner. Through the GFWG, Macquarie maintains a register of green financing transactions and eligible projects, and has implemented appropriate monitoring and reporting processes.

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Reporting Macquarie publishes an annual ‘Green Finance Impact Report’ providing information on the allocation, reporting and impacts of its green loan tranches. This uses the proprietary green impact reporting methodologies developed by the UK’s Green Investment Bank (acquired by Macquarie) including: ●● ●●

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estimates of greenhouse gas emissions avoided; metrics for other environmentally harmful impacts avoided – fossil fuel consumption, air pollutant emissions, waste to landfill avoided and materials recycled and recovered; and performance against the UN Sustainable Development Goals and their associated targets.

QUICK QUESTION What might prevent banks from adopting the Green Loan Principles?

As can be seen from the case study above, there can be substantial costs and complexity involved in following the Green Loan Principles, especially where a bank lacks the in-house capacity, capability, expertise and experience to develop approaches, frameworks and tools for the use of proceeds, project selection and reporting. Additional costs mean the Principles tend to be applied to larger lending facilities, such as the syndicated loans described above, or to substantial credit facilities for large corporate borrowers. Over time, however, as capacity and capabilities develop, more banks and other lenders will be able to apply the Principles to an increasing number of lending programmes, bringing greater consistency and credibility to the rapidly developing market for green loans.

Social Loan Principles The LMA, APLMA and Loan Syndications and Trading Association (LSTA) have also developed Social Loan Principles (SLPs).52 The SLPs closely mirror the Green Loan Principles in their approach and framework (use of proceeds, project evaluation and selection, management of proceeds and reporting) but, as the name suggests, they are applied in the context of social sustainability (‘lending for social purposes’)

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rather than environmental sustainability. They mirror the approach used by the Social Bonds Principles, which we describe in Chapter 7. In terms of use of proceeds, ‘social projects’ are defined in the SLPs as those which ‘directly aim to address or mitigate a specific social issue and/or seek to achieve positive social outcomes especially but not exclusively for a target population(s). A social issue threatens, hinders or damages the well-being of society or of a specific target population.’ The SLPs also provide examples of eligible categories: ●●

affordable basic infrastructure (e.g. drinking water)

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access to essential services (e.g. healthcare)

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affordable housing

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reducing unemployment (including stimulating the growth of SMEs)

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food security and sustainable food systems

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socioeconomic advancement, empowerment and equality

The SLPs, therefore, provide a framework and market standards for social lending by institutions, with the aim of promoting global consistency in and the development of the market for social loans.

Sustainability-linked loans One feature of green and sustainable lending that is becoming increasingly common is margin adjustment, where borrowers able to demonstrate their sustainable credentials and/or evidence of sustainability plans and targets benefit from lower interest rates. Thus, borrowers have a financial incentive to improve their sustainable activities. Conversely, less sustainable borrowers may need to pay a premium to access finance. Referred to as sustainability-linked loans (SLLs), these are an important mechanism for supporting organizations’ transitions to more environmentally and socially sustainable business models. Margin adjustments may cover a wide range of sustainability goals, including but not limited to climate change mitigation and adaptation, broader environmental objectives, health and safety, and equality and inclusion, as we explore in the three case studies below. Establishing the criteria for and measuring the attainment of sustainability targets tends to be performed by an independent third-party expert (and are features of the new Sustainability Linked Loan Principles, described below). The extent to which interest rates are adjusted varies significantly, based on the individual features of the loan, the use of proceeds, the client and the sustainability targets agreed.

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CASE STUDY Tesco links £2.5 billion loan to key emissions, energy and food waste targets53 In 2020, Tesco agreed a £2.5 billion sustainability-linked loan in the form of a revolving credit facility (RCF) led by BNP Paribas and NatWest. Tesco would benefit from a lower interest rate if the retailer met agreed environmental performance targets, including: ●● ●● ●●

reducing Scope 1 (direct) and Scope 2 (power-related) emissions; increasing the proportion of renewable energy used; and re-distributing surplus food.

Overall, Tesco aims to reduce operational emissions by 60 per cent by 2025, against a 2015–16 baseline, and to reach net zero by 2050 in line with the science-based targets. The RCF helps incentivize Tesco’s transition plans by linking the cost of finance with improved sustainability performance.

CASE STUDY CBA sustainability-linked loan recognized in Environmental Finance Awards54 In March 2020, Commonwealth Bank of Australia (CBA) and Wesfarmers signed an AUS $400 million three-year bilateral sustainability-linked loan, the largest to be offered by a single lender. The loan incentivized Wesfarmers to increase the proportion of indigenous employment across the group, and to deliver enhanced environmental outcomes through reduced carbon emissions intensity in their chemicals arm, by linking the interest charged on progress in these areas. Although there had been SLLs in the global market previously, the Wesfarmers and Commonwealth Bank loan generated significant global interest, with the loan being recognized in the UK-based 2020 Environmental Finance IMPACT Awards. Publicity and positive reaction to the CBA initiative led to increased demand for similar SLLs in Australia. As of September 2020, just six months after the issue of the CBA/Wesfarmers SLL, a total of AUS $2.45 billion worth of SLLs had been issued in Australia.

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CASE STUDY EQT launches ESG-linked Subscription Credit Facility55 Private equity firm EQT unveiled its ESG-linked Subscription Credit Facility in November 2020. With a ceiling of around €5 billion, the facility aims to inspire and incentivize companies in EQT’s portfolio to improve their performance in the areas of: ●●

gender equality on boards

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renewable energy transition

Aggregated results from the portfolio companies’ progress will be compared with pre-set targets and will eventually impact the facility’s interest rate. In short, the more progress portfolio companies demonstrate towards the sustainability targets, the better the financing terms they will receive. EQT anticipates that, as targets are fulfilled, societal impacts will be substantial. The firm expects to improve female board representation to 40 per cent and the use of renewable electricity to 85 per cent across its portfolio companies.

Early SLLs were documented on a ‘one-way’ pricing basis – if the borrower satisfied certain pre-determined sustainability targets, a discount was applied to the margin payable on the loan. If targets were missed, or sustainability performance declined over the term of the loan, the discount did not apply and the pricing remained unchanged. Such pricing structures have increasingly been replaced by ‘two-way’ pricing structures, where improvement in sustainability performance still triggers a discount to the margin, but weakening performance triggers an increase in the margin instead. The sustainability targets used in early SLLs tended to rely on the borrower’s overall ESG scores, assigned by a third-party ESG rating agency. Pricing changes were triggered by a change in the ESG score. For example, if a borrower had an ESG score of 60 on a scale of 0–100 at the start of the period, the loan agreement might set a threshold of 65 on subsequent assessments as the trigger for a discount. As the market has developed, more specific and tailored KPIs linked to environmental or social sustainability performance targets and impacts (as in the Tesco case study above) have become the norm, as set out in the Sustainability Linked Loan Principles.

Sustainability Linked Loan Principles To support the development of the market for SLLs and bring greater consistency to their application, the LMA, APLMA and LSTA published the Sustainability Linked

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Loan Principles (SLLPs) in 2019.56 Unlike the Green Loan and Social Loan Principles described above, the ‘use of proceeds’ is not a key feature of an SLL; rather an SLL aims to incentivize a borrower’s sustainability profile. To do this, defining appropriate sustainability performance targets (SPTs), measured by predefined key performance indicators (KPIs), is key. SLLs may be structured to align with the Green Loan or Social Loan Principles, too, but this is not required. The SLLPs are voluntary process guidelines that set out a framework for a range of loan instruments that may utilize the Principles, based on: ●●

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Selection of KPIs: These should be relevant, core and material to the borrower’s overall business; of high strategic significance; be measurable and be able to be benchmarked using an external reference. Calibration of SPTs: These should be ‘ambitious’, representing a material improvement on the respective KPIs, and where possible be compared to a benchmark or other external reference. Loan characteristics: There should be an economic outcome linked to the SPTs (for example, a margin discount when one or more SPTs are met). Reporting: Borrowers should provide lenders with up-to-date information to allow them to monitor the performance of SPTs; they are encouraged (but not required) to publish information relating to SLLs and SPTs in publicly available annual and sustainability reports. Verification: Borrowers must obtain independent and external verification of the borrower’s performance level against each SPT for each KPI at least once a year (again, it is recommended but not required that this be publicly disclosed).

The SLLPs also include a list of common KPIs covering both environmental and social sustainability that can be used as a basis for calibrating SPTs between lenders and borrowers. The LMA has also published guidance to support the SLLPs, as well as additional guidance to support the application of the SLLPs to leveraged loans (loans to borrowers that already have significant debt outstanding).57 Further guidance to support the continued development of the SLLs – an important instrument for supporting organizations’ transitions to more sustainable business models – will be forthcoming.

Commercial real estate lending We have seen in earlier chapters that the built environment is a major source of greenhouse gas emissions. Commercial real estate lenders can therefore play an important part in supporting the transformation towards a more sustainable built environment by using green and sustainability linked loans to incentivize commercial property developers, owners and tenants to reduce emissions from their real estate portfolios and operations.

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In a way similar to green mortgages, these link the terms and pricing of a loan to a property’s environmental impact, energy efficiency or other agreed characteristics. Loans may be formally aligned with the Green or Sustainability Linked Loan Principles introduced above or not (as in the Lloyds Banking Group case study below). As commercial property building codes and other legislation and regulation have been tightened in many jurisdictions in terms of energy efficiency, emissions and other criteria, bank financing is often linked to the achievement of performance certificates or other standards evidencing these.

CASE STUDY Lloyds Banking Group Green Lending Initiative58 Lloyds Banking Group is one of the UK’s largest commercial real estate lenders, with a £13.8 billion portfolio. Recognizing the scale of its commercial lending activities and the potential impact it could have, the bank has developed a new product that provides commercial real estate funding at advantageous rates to reward and incentivize better environmental performance. Lloyds’ Green Lending Initiative was launched in March 2016, with a pledge of £1 billion of commercial mortgage lending aimed at reducing CO2 emissions from clients’ real estate assets. This first-of-its-kind (in the UK) fund will be used to incentivize clients’ adoption of energy efficiency measures by offering margin enhancements of up to 20bps on new borrowing requirements of £10 million and above where borrowers meet and maintain agreed energy efficiency and emissions reduction targets. Lloyds expects the Green Lending Initiative to facilitate carbon savings equivalent to approximately 110,000 tonnes CO2e based on the average four-year loan tenor (length). This is equivalent to the annual energy usage of approximately 22,000 UK households. Through this programme, Lloyds Banking Group aims to support its clients’ sustainability programmes, incentivize improved energy efficiency and data flow, and catalyse the UK market for green loans. Lloyds has worked with Trucost, an environmental consultancy firm, to create a tool to benchmark real estate sustainability performance. This will be used to assess initial eligibility for green loans and to agree appropriate energy efficiency and emissions reduction targets for borrowers.

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Project finance Project finance refers to loans offered by corporate and investment banks to fund large infrastructure or similar projects that require substantial capital investment in sectors such as energy, petrochemicals and natural resources. A project financing structure typically involves several equity investors, known as ‘sponsors’, and a ‘syndicate’ of banks or other lending institutions that provide loans to (usually) a special purpose entity created for the project. The project entity obtains loans that are repaid through the project revenue generated rather than through the balance sheets of its sponsors. Some banks, such as BBVA in the case study below, have developed specific project finance products for green and sustainable initiatives such as large-scale renewable energy projects. Given the importance of investing in climate-positive and climateresilient infrastructure to achieve the goals of the Paris Agreement, project finance is a very important component within green and sustainable finance overall.

CASE STUDY BBVA project finance59 In July 2017, BBVA signed a project finance green loan with Italian energy company Terna. The first of its kind in the world, the funding will enable Terna to build a transmission line between the cities of Melo and Tacuarembó in Uruguay. Funding was structured into a $56 million A loan awarded by the Inter-American Development Bank (IDB) and a $25 million B loan subscribed by BBVA in its entirety. In addition to heading the green structuring of the funding, BBVA acted as the Green Loan Coordinator. In accordance with the Green Bond Principles, the loan was structured as a green instrument based on certification by Vigeo Eiris. The benefits of building the transmission line include: ●●

connecting projects for the generation of renewable energy to the country’s electrical grid;

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contributing to the fight against climate change; and

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contributing towards the achievement of the Sustainable Development Goals.

Trade finance International trade involves buying and selling over extended periods across countries with different legal systems, cultures and business environments. Financing exports, therefore, is often riskier and more complex than financing domestic business.

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Typically, there is less understanding and trust between suppliers and customers in different countries, a requirement to transact in foreign currencies and longer lead times for physical trade to take place. Given that few exporters can sell to customers who will routinely pay in advance, this often leads to cash flow issues, and creates a need for short-term, interim finance in the form of credit, insurance and guarantees. Due to the risks associated with international trade, the World Trade Organization (WTO) estimates that between 80 per cent and 90 per cent of world trade relies on trade finance,60 most of which is provided by banks. Trade finance enables and supports the production, trade, shipping and processing of most commodities, including those linked to environmental harm – including soy, palm oil, timber and beef. Banks, therefore, have a unique role in working across commodity supply chains to support sustainable production. According to the University of Cambridge Institute for Sustainability Leadership, through trade finance banks can promote environmentally sustainable production and distribution by: ●●

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developing new trade finance products and services that enable environmental and other sustainability factors to be traced and identified; incentivizing the production of sustainable commodities by finding ways to reduce the price differential between the trade of these relative to unsustainable alternatives; and amplifying demand signals by committing to finance only sustainably produced commodities progressively over time.61

CASE STUDY Sustainable Shipment Letter of Credit62 The University of Cambridge Institute for Sustainability Leadership Banking Environment Initiative (BEI) seeks to explore ways to scale up the role that banks can play in supporting the shift towards sustainable commodity supply chains. One initiative established and tested is the Sustainable Shipment Letter of Credit. The Sustainable Shipment Letter of Credit (SSLC) was developed with the aim of increasing transparency regarding the export of certified sustainable palm oil in emerging markets, and thereby reducing the costs of doing so. This would address a key issue in the palm oil market, namely that importers often do not favour sustainable methods of production because of the premium prices expected, leaving producers with mixed demand signals. The SSLC enables sustainability information, in the form of internationally recognized certification standards, to be captured in Letter of Credit documentation.

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The SSLC therefore provides greater transparency and enables parties to identify whether a particular shipment is certified. The document itself does not incentivize the trade of certified sustainable palm oil, but it enables banks and other to do so if they wish. For example, the International Finance Corporation (IFC) decided to offer preferential terms to banks financing sustainable palm oil shipments via the SSLC mechanism through its Global Trade Finance Program. This created an immediate economic case for banks, in turn, to be able to offer price reductions to those of their clients who choose to trade sustainably certified palm oil, increasing demand for this. The Sustainable Trade Finance Council has been exploring how the SSLC approach can be expanded beyond palm oil to other forest-sensitive commodities, and beyond the Letter of Credit to other trade finance instruments, including guarantees and insurance.

Asset finance and leasing Asset finance (leasing) is where banks lend equipment to firms in exchange for regular payments, whilst retaining ownership of the assets. A very wide range of equipment can be financed in this way, including machinery and vehicles. The advantage of leasing is that it enables a borrower to get the benefit of using the equipment (e.g. a fleet of electric vans for distribution) without having to pay the up-front capital costs. Through ‘green leasing’, banks and leasing companies provide customers with environmentally friendly technologies, such as energy-efficient equipment or electric vehicles, at preferential rates. Leasing can play an important role in promoting the uptake of green equipment and technologies, therefore, and help banks’ corporate customers transition their production, distribution and business models to net zero. Some European governments have played a significant role in promoting green leasing through public awareness campaigns, business incentive programmes and tax incentives.

CASE STUDY DLL Clean Technology Financing/Life Cycle Asset Management63 DLL, a subsidiary of the Dutch bank Rabobank, seeks to encourage the transition to circular business models by offering innovative leasing solutions that enable lessors to use rather than own their assets.

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DLL’s Clean Technology Financing scheme provides access to manufacturing and office equipment supporting the use of renewable energy and electric vehicles, the installation of energy efficiency measures, and reducing water and waste. The energy and other savings made partially offset the cost of the leasing payments, improving the lessor’s cash flow. DLL also promotes ‘circular’ business models through its Life Cycle Asset Management programme, which focuses on the repair, re-use and redeployment of leased assets rather than replacement, including ‘second life’ financing where refurbished assets are re-leased to a new lessor. In addition, pay-per-use models further encourage the sustainable management of leased assets In 2016, DLL was named the winner of the ‘Alliance Trust Award for Circular Economy Investor’ at the World Economic Forum. Organized by the Forum’s Young Global Leaders in conjunction with Accenture, the award is presented to financial institutions that help build the circular economy.

Green corporate deposit schemes Some banks have established green or ESG corporate deposit schemes in response to growing client demand for products that create positive environmental and social impacts. Much like green current accounts for retail customers, these provide a facility for organizations – often, but not necessarily, charitable or public sector bodies – to deposit money with a bank in the knowledge that it will be invested in initiatives that have a positive social or environmental impact. In 2015, for instance, Lloyds Banking Group in the UK launched a new ESG deposit scheme, under which deposited funds were used to make loans to finance SMEs, healthcare providers and renewable energy and energy efficiency projects in the most economically disadvantaged parts of the UK. Another example is the Westpac Green Tailored Deposit Scheme described in the case study below.

CASE STUDY Westpac Green Tailored Deposit Scheme64 In November 2018, Australian bank Westpac launched a ‘Green Tailored Deposit’ (GTD) scheme for corporate customers seeking to support climate change mitigation and adaptation projects.

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A minimum of AU $1 million can be deposited for between one and five years. Deposits will be allocated to a pool of eligible assets or projects supporting renewable energy, low-carbon buildings and cleaner transport, and improving water infrastructure. The scheme is the first such deposit scheme to be certified by the Climate Bonds Initiative. Commenting on the launch, Westpac Institutional Bank CEO Lyn Cobley said, ‘This is a great example of Westpac’s customer-driven innovation. The new green tailored deposit delivers an innovative solution for customers seeking an independently certified green investment product.’ The launch of the GTD scheme was supported by two Australian public institutions that agreed to be among the first investors – the City of Sydney Council (with AU $30 million in GTDs, at rates between 2.65 and 3 per cent, and maturities of up to five years), and the South Wales Central Coast Council. Other Australian local government institutions are expected to follow suit.

Initial public offerings and underwriting One of the primary roles of an investment bank is to serve as an intermediary between corporations and investors through initial public offerings (IPOs). Investment banks provide underwriting services for new share issues when a company decides to go public and raise equity funding. Underwriting involves the investment bank purchasing an agreed number of new shares, which it then re-sells through a stock exchange. Typically, there is a ‘bookrunner’ that syndicates with other investment banks to lower its risk. When more than one bookrunner manages an issuance, the parties are referred to as joint bookrunners. In deciding which sectors and firms to support, investment banking activity can have significant positive or negative environmental, social or other consequences. When positive, banks can play a key role in facilitating the transition to a low-carbon economy. Investment banks can lead IPOs for companies supporting the transition to net zero, such as those in the renewable energy, energy storage, energy efficiency, low-carbon transport and recycling sectors. Given the recent rapid growth in investor interest in such sectors, and significant increases in the share price of high-profile ‘green’ stocks such as Tesla, the number of IPOs in this area continues to increase. This brings with it an associated risk of greenwashing, however, if firms seeking an IPO mislead investors as to the true extent of their alignment with the goals of the Paris Agreement and other sustainable objectives.

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Investment banks also help firms raise capital by underwriting the issuance of securities, including bonds and equities. As we will discuss in the following chapter, the market for green bonds and other sustainable debt securities has grown rapidly in recent decades, and we will explore equities and investment in Chapter 9. Investment banks play a key role in supporting and mainstreaming these markets by underwriting issuances and stimulating investor demand.

QUICK QUESTION What might be the wider (beyond financial) benefits to an investment bank of supporting a ‘green IPO’?

Research and advisory services Corporate and investment banks offer a wide range of research and advisory services that can contribute significantly to the greening of the financial system. By questioning and critiquing companies’ performance and plans, for example, sell-side research analysts can help to shape debates on firms’ environmental, social and sustainability performance, and hold their boards and senior executives to account. Many banks have established dedicated in-house research teams on climate and sustainability issues that can influence decisions, both internally and externally, on whether a bank should provide finance, and to prompt clients to integrate environmental and other factors in their decision making.

Key concepts In this chapter, we considered: ●●

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how banking can impact the environment and society – both positively and negatively – and play a key role in a successful transition to net zero; the UN Principles for Responsible Banking and the Net Zero Banking Alliance, and how these support the alignment of banking with the goals of the Paris Agreement and the UN Sustainable Development Goals; how banking products and services can align finance with the Paris Agreement and other sustainability objectives, and support customers and clients in adopting more sustainable business models and behaviours;

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examples and case studies of innovative, responsible green and sustainable banking products and services; and the Green Loan Principles, Social Loan Principles and Sustainability Linked Loan Principles.

Now go back through this chapter and make sure you fully understand each point.

Review There are four main types of banks: retail banks serving individuals and small businesses, corporate and investment banks serving larger clients, central banks, and national and multilateral development banks. This chapter focused on retail and corporate banks, describing how they are well positioned to respond to (and shape) consumer preferences, and to reallocate credit and mobilize capital towards environmentally and socially sustainable economic activities. Banks are the main source of credit for households and firms in most economies. They play a major role in capital markets, too, and therefore in a successful economic and societal transition to net zero. Banks are uniquely positioned to reallocate credit and mobilize capital away from environmentally and socially harmful activities towards green and sustainable projects and activities. By continuing to finance highcarbon, environmentally or socially damaging activities, however, banks contribute to the acceleration and impacts of climate change, and wider environmental and societal harms. All types of retail and corporate banks, large and small, play key roles in both ‘greening finance’ and ‘financing green’. In terms of the former, many banks now embed environmental and other sustainability factors into their strategies, activities and operations. In terms of the latter, retail and corporate banks can mobilize private capital for lending to and investing in environmentally and socially sustainable activities through loans and other products and services to households and firms, and through their advisory, intermediation and capital markets activities. There are two key banking sector initiatives to align banking with sustainability. The UN Principles for Responsible Banking (PRB) provide a global framework for banks to align their strategies, activities and operations with the objectives of the Paris Agreement and the UN Sustainable Development Goals (SDGs), together with a peer network, target setting, impact analysis and reporting mechanisms to support this. The UN-convened Net Zero Banking Alliance (NZBA) is the banking constituent alliance of GFANZ. NZBA members commit to aligning their lending and investment portfolios to limit global warming to 1.5°C above pre-industrial levels by 2050 in line with science-based targets, and to set interim 2030 targets and intermediary targets every five years from 2030 onwards.

Responsible retail, commercial and corporate banking

As retail banks tend to have (or at least seek) close relationships with individual customers, they play a key role in understanding and shaping customer needs and expectations. Retail banks are well placed to respond to changing attitudes towards the environment, and to help customers shift towards more sustainable modes of consumption and production by offering products and services that enable them to save, invest and borrow in a more sustainable manner. Green and sustainable retail banking products and services include: ●●

current accounts, cards and payment services

●●

savings

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green and retrofit mortgages

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electric vehicle finance

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small and micro business lending.

Corporate and investment banks provide banking products and services to large organizations, including loans to finance investment, project finance for large infrastructure or industrial projects, and trade finance to help companies buy and sell from abroad. Green and sustainable corporate and investment banking products and services include: ●●

green and sustainable corporate loans

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green corporate deposit schemes

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project finance

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trade finance

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asset finance and equipment leasing

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initial public offerings and underwriting

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research and advisory services

Green lending plays a key role in reallocating capital to support the transition to a low-carbon world. The Green Loan Principles promote consistency in green corporate lending to maintain the integrity of the green loan market and avoid greenwashing. Whilst voluntary, the Principles are endorsed by a wide range of institutions and have become generally accepted as market standards, increasingly referenced beyond the syndicated loan market they were originally developed to support. Similar, Social Loan Principles have also been developed. Sustainability-linked loans (SLLs) are becoming a popular instrument for fi ­ nancing environmental and other sustainability objectives and supporting organizations’ transitions to more sustainable business models. SLLs typically include a margin adjustment, where the interest rate on the loan is reduced as sustainability targets are met. The Sustainability Linked Loan Principles support the development of the market for SLLs, and ensure consistency by defining key features of such loans, including key performance indicators (KPIs) and sustainability performance targets (SPTs).

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Table 6.1  Key terms Term

Definition

Green loan

A loan made available to finance or refinance, in whole or in part, new and/or existing projects designed to achieve positive environmental outcomes. Although not a legal requirement, it is good practice for green loans to align with the Green Loan Principles.

Green Loan Principles A voluntary framework and standards for lending to support (GLPs) positive environmental outcomes, developed by the Loan Market Association and others, designed to promote global consistency in the application and reporting of green loans. Green mortgage

A mortgage on an energy-efficient home, usually (at present) referring to new-build homes.

Green tagging

Linking the terms of a loan to the underlying asset’s energy performance, fuel efficiency or environmental standard.

Investment banking

Helping companies raise debt and equity finance through capital markets.

IPO

Initial Public Offering.

Margin adjustment

A variation in loan pricing (interest rate) linked to a borrower’s ability to meet agreed targets. In the context of green and sustainable finance, these may relate to improvements in energy efficiency or other sustainable aims such as reducing pollution or waste.

Partial credit guarantee

Partial insurance against non-payment by a borrower for any reason – political, commercial or otherwise.

Project finance

Funding for large infrastructure projects, typically including a combination of equity investors and a syndicate of banks or other lending institutions that provide loans that are repaid through revenue generated by the project.

Retail banking

The provision of products and services by a bank to individual consumers and SMEs.

Social loan

A loan made available to finance or re-finance, in whole or in part, new and/or existing projects designed to achieve positive social outcomes. Although not a legal requirement, it is good practice for social loans to align with the Social Loan Principles.

Social Loan Principles (SLPs)

A voluntary framework and standards for lending to support positive social outcomes, developed by the Loan Market Association and others, designed to promote global consistency in application and reporting of social loans. (continued)

Responsible retail, commercial and corporate banking

Table 6.1  (Continued) Term

Definition

Sustainability-linked loan (SLL)

A corporate loan where the pricing (interest rate) and/or other features are dependent on the sustainability profile and targets of the borrower. Although not a legal requirement, it is good practice for SLLs loans to align with the Sustainability Linked Loan Principles.

Sustainability Linked Loan Principles (SLLPs)

A voluntary framework and standards for lending, developed by the Loan Market Association and others, designed to support the development of the Sustainability Linked Loan (SLL) market and consistency in the application of SLLs.

Syndicated loan

A large loan offered by a group of lenders – referred to as a syndicate – that work together to provide funds for a single borrower to finance a major project.

Trade finance

Products and services offered by banks to help exporters manage cash flow, credit risk, exchange risk and other risks of trading internationally.

UN Principles for Responsible Banking

Launched in September 2019 with 130 banks from 49 countries as the founding signatories, the Principles provide a framework for banks to align their strategies and activities with sustainable finance principles and societal goals, as expressed in the UN Sustainable Development Goals and the Paris Agreement.

Wholesale banking

The provision of products and services by a bank to larger corporations and to other banks.

Notes 1 SEB (2021) SEB sets new climate ambitions and goals as part of its sustainability strategy, https://sebgroup.com/press/press-releases/2021/seb-sets-new-climate-ambitions-and-goalsas-part-of-its-sustainability-strategy (archived at https://perma.cc/Q8ZC-6XS6) 2 Rainforest Action Network (2022) Banking on Climate Chaos 2022, https://www. bankingonclimatechaos.org//wp-content/themes/bocc-2021/inc/bcc-data-2022/ BOCC_2022_vSPREAD.pdf (archived at https://perma.cc/9G48-VQCX) 3 Ibid 4 ShareAction (2020) Banking on a Low-Carbon Future II, https://shareaction.org/ wp-content/uploads/2020/04/ShareAction-Banking-Report-2020.pdf (archived at https:// perma.cc/Z9J4-A3AJ). 5 ShareAction (2021) Countdown to COP26 – An analysis of the climate and biodiversity practices of Europe’s largest banks, https://api.shareaction.org/resources/reports/ Countdown-to-COP26.pdf (archived at https://perma.cc/7RVR-LZRE)

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Green and Sustainable Finance 6 CISL (2020) Bank 2030: Accelerating the transition to a low carbon economy,­ www.cisl. cam.ac.uk/resources/sustainable-finance-publications/bank-2030-acceleratingthe-transition-to-a-low-carbon-economy (archived at https://perma.cc/74VQ-QFSQ) 7 UNEP FI (nd) Principles for Responsible Banking, https://www.unepfi.org/banking/­ bankingprinciples/ (archived at https://perma.cc/C82B-CLL7) 8 UNEP FI (nd) Signatories, https://www.unepfi.org/banking/bankingprinciples/­ prbsignatories/ (archived at https://perma.cc/NU23-ECXG) for list of PRB signatories 9 UNEP FI (nd) About the Principles, https://www.unepfi.org/banking/bankingprinciples/ more-about-the-principles/ (archived at https://perma.cc/QX3E-ECPJ) 10 UNEP FI (2020) Impact Analysis: Guidance for Banks, https://www.unepfi.org/publications/ guidance-on-impact-analysis/ (archived at https://perma.cc/J82D-RP4M) 11 UNEP FI (2021) Responsible Banking: Building foundations. The first collective progress report of the UN Principles for Responsible Banking signatories, https://www.unepfi. org/wordpress/wp-content/uploads/2021/10/Responsible-Banking-Building-FoundationsReport.pdf (archived at https://perma.cc/8KWQ-GTSR) 12 UNEP FI (nd) Target setting, https://www.unepfi.org/banking/bankingprinciples/ resources-for-implementation/target-setting/ (archived at https://perma.cc/ZNR9-UW55) 13 UNEP FI (2020) Reporting: Guidance for banks, https://www.unepfi.org/publications/ guidance-on-reporting-and-providing-limited-assurance/ (archived at https://perma.cc/ S8TR-MWPR) 14 For examples of PRB signatories’ reports, see https://www.unepfi.org/banking/­ bankingprinciples/prbsignatories/ (archived at https://perma.cc/NU23-ECXG) 15 UNEP FI (nd) Collective Commitment to Climate Action, https://www.unepfi.org/ banking/­bankingprinciples/commitments/ccca/ (archived at https://perma.cc/7K4R-6D32) 16 UNEP FI (nd) Net-Zero Banking Alliance, https://www.unepfi.org/net-zero-banking/ (archived at https://perma.cc/V7F2-C6DW) 17 UNEP FI (2021) The Commitment, https://www.unepfi.org/net-zero-banking/­ commitment/ (archived at https://perma.cc/WW5X-Z7PP) 18 UNEP FI (2021) Guidelines for Climate Target Setting for Banks, https://www.unepfi. org/wordpress/wp-content/uploads/2021/04/UNEP-FI-Guidelines-for-Climate-ChangeTarget-Setting.pdf (archived at https://perma.cc/2KVP-R2DB) 19 Ekobanken (2021) About Ekobanken, https://www.ekobanken.se/en/about-ekobanken/v (archived at https://perma.cc/VR4N-RYLG) 20 south pole (nd) Case Study: Climate Credit Card, www.southpole.com/clients/climatecredit-card-make-expenses-climate-neutral (archived at https://perma.cc/5ZF5-N8RZ) 21 UN: Climate Change (2022) Alipay Ant Forest: Using digital technologies to scale up climate action | China, https://unfccc.int/climate-action/momentum-for-change/planetaryhealth/alipay-ant-forest (archived at https://perma.cc/DXR3-65L4) 22 CIMB (nd) Ecosave Savings Account-i, https://www.cimb.com.my/en/personal/dayto-day-banking/accounts/savings-account/ecosave-savings-account-i.html (archived at https://perma.cc/4E7R-MNZL) 23 YES BANK (2022) The Circle of Goodness, https://www.yesbank.in/beyond-banking/ responsible-banking/positive-impact/the-circle-of-goodness (archived at https://perma. cc/KXR6-B6LW); The Times of India (2018) Yes Bank launches deposit scheme, https:// timesofindia.indiatimes.com/business/india-business/yes-bank-launches-deposit-scheme/ articleshow/64465594.cms (archived at https://perma.cc/PNP6-ACXU)

Responsible retail, commercial and corporate banking 24 Ecology (2022) Ecology Cash ISA, www.ecology.co.uk/savings/savings-accounts/ecologycash-isa/ (archived at https://perma.cc/F59F-HGHC) 25 Abundance Investments (2022) Home, www.abundanceinvestment.com (archived at https://perma.cc/W29X-4QGF) 26 UBank (nd) Term Deposits, https://www.ubank.com.au/term-deposits/green# (archived at https://perma.cc/LDD5-SKXE) 27 Climate Change Committee (2021) The Sixth Carbon Budget: Buildings, https://www. theccc.org.uk/wp-content/uploads/2020/12/Sector-summary-Buildings.pdf (archived at https://perma.cc/Z2CP-YGW4) 28 IPCC (2014) Buildings. In: Climate Change 2014: Mitigation of Climate Change. Contribution of Working Group III to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change, https://www.ipcc.ch/site/assets/ uploads/2018/02/ipcc_wg3_ar5_chapter9.pdf (archived at https://perma.cc/43RT-CBJA) 29 Institute for Market Transformation (2013) Home energy efficiency and mortgage risks, https://www.imt.org/wp-content/uploads/2018/02/IMT_UNC_ HomeEEMortgageRisksfinal.pdf (archived at https://perma.cc/S3B2-RMQK) 30 Bank of England (2020) Does energy efficiency predict mortgage performance? Staff Working Paper No. 852, https://www.bankofengland.co.uk/working-paper/2020/ does-energy-efficiency-predict-mortgage-performance (archived at https://perma. cc/9EFD-HVGK) 31 Billio, M et al (2021) Buildings’ energy efficiency and the probability of mortgage default: The Dutch case, https://link.springer.com/article/10.1007/s11146-021-09838-0 (archived at https://perma.cc/3NP7-UE9T) 32 Barclays (2018–22) Barclays Green Home Mortgages, https://www.barclays.co.uk/­mortgages/green-home-mortgage/ (archived at https://perma.cc/H59Q-SHGG); Green Finance Institute (2022) Green Mortgages, https://www.greenfinanceinstitute.co.uk/ programmes/ceeb/green-mortgages/ (archived at https://perma.cc/8U3B-D7K7) 33 Ecology Building Society (nd) C-Change Discounts, https://www.ecology.co.uk/ mortgages/c-change-discounts/ (archived at https://perma.cc/L56Z-UHYJ) 34 Green Finance Institute (2020) Green Home Finance Principles, https://www. greenfinanceinstitute.co.uk/wp-content/uploads/2021/09/GREEN-FINANCE-GREENHOMES-REPORT-NEW-a.pdf (archived at https://perma.cc/39PZ-783D) 35 Short, D and Botten, C (2017) Beyond Risk Management: How sustainability is driving innovation in commercial real estate finance, https://www.betterbuildingspartnership. co.uk/sites/default/files/media/attachment/BBP_BeyondRiskManagement_Insight_Final. pdf (archived at https://perma.cc/8XAW-J7T5) 36 PCAF (nd) Financial institutions taking action, https://carbonaccountingfinancials.com/ financial-institutions-taking-action (archived at https://perma.cc/8EYN-6WHB) 37 BBC (2020) How our daily travel harms the planet, https://www.bbc.com/future/ article/20200317-climate-change-cut-carbon-emissions-from-your-commute (archived at https://perma.cc/5HLZ-VDQ9) 38 Bank Australia (2022) Car Loan, https://www.bankaust.com.au/personal/borrow/ personal-loans/car-loan/ (archived at https://perma.cc/SPJ2-VR4V)

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Green and Sustainable Finance 39 Energy Saving Trust (2022) Grants and loans: electric vehicle loan, https://energysavingtrust.org.uk/grants-and-loans/electric-vehicle-loan/ (archived at https://perma.cc/6GNP-ZRQ8) 40 HSBC (nd) Our climate strategy, https://www.hsbc.com/who-we-are/our-climate-strategy/ climate-solutions-and-innovation (archived at https://perma.cc/5ML2-TD55) 41 Lloyds Bank (nd) Clean Growth Financing Initiative, https://www.lloydsbank.com/ business/commercial-banking/clean-growth-financing-initiative.html (archived at https:// perma.cc/8VMB-PC4U) 42 Nordea Bank (2020) Green Business Loans, https://www.nordea.fi/en/business/ourservices/financing/green-business-loans.html (archived at https://perma.cc/7Y9R-7A5S) 43 The Lab (nd) GreenFi | Climate-Smart Lending Platform, https://www.climatefinancelab. org/project/climate-smart-finance-smallholders/ (archived at https://perma.cc/JC97-XTR7) 44 hiveonline (2021) Rethinking VSLA Community Finance, https://www.hivenetwork. online/rethinking-vsla-community-finance/ (archived at https://perma.cc/2YN3-44M5) 45 TheCityUK (2022) Green Finance: A quantitative assessment of market trends, https:// www.thecityuk.com/research/green-finance-a-quantitative-assessment-of-market-trends/ (archived at https://perma.cc/ZPB7-KZDR) 46 GBTI Bank (2020) https://www.gbtibank.com/ (archived at https://perma.cc/ U35X-Z9ZW) 47 Loan Market Association (2021) Green Loan Principles, https://www.lma.eu.com/ application/files/9716/1304/3740/Green_Loan_Principles_Feb2021_V04.pdf. (archived at https://perma.cc/Y5XD-VQ95) 48 Ibid 49 Loan Market Association (2021) Guidance on Green Loan Principles, www.lsta.org/ content/green-loan-principles/ (archived at https://perma.cc/6YLL-RQRZ) 50 Loan Market Association (2021) Sustainable Lending Glossary of Terms, https://www. lma.eu.com/application/files/3316/2816/5371/LMA_Sustainable_Lending_Glossary_V10. pdf (archived at https://perma.cc/GHE9-KSGX) 51 Macquarie (2020) Green Finance Impact Report, https://www.greeninvestmentgroup. com/assets/gig/what-we-do/green-impact-advisory/macquarie-green-finance-impactreport-2020.pdf (archived at https://perma.cc/6GUQ-UQPV) 52 Loan Market Association (2021) Social Loan Principles, https://www.lma.eu.com/­ application/files/1816/1829/9975/Social_Loan_Principles.pdf (archived at https://perma. cc/YNW4-6BXF) 53 edie newsroom (13 October 2020) Tesco links £2.5bn loan to key emissions, energy and food waste targets, www.edie.net/news/7/Tesco-links--2-5bn-loan-to-key-emissions-energy-and-food-waste-targets/?utm_source=dailynewsletter,%20edie%20daily%20 newsletter&utm_medium=email,%20email&utm_content=news&utm_campaign=dailyn​ ewslette,percent202426d3e441-dailynewsletter_COPY_906r (archived at https://perma. cc/48S2-4SNE) 54 Environmental Finance (2020) https://www.environmental-finance.com/content/awards/ impact-awards-2020/cba-wesfarmers-target-employment-and-emissions.html (archived at https://perma.cc/VY3H-LR37)

Responsible retail, commercial and corporate banking 55 EQT Press Release (2020) EQT continues to accelerate portfolio companies’ ESG performance, https://www.eqtgroup.com/news/Press-Releases/2020/eqt-continues-toaccelerate-portfolio-companies-esg-performance/ (archived at https://perma.cc/ 85A4-T6YX) 56 Loan Market Association (2019) Sustainability Linked Loan Principles, https://www. lma.eu.com/application/files/6816/2668/7155/Sustainability_Linked_Loan_Principles._ V09.pdf (archived at https://perma.cc/RN5T-ELNS) 57 Loan Market Association (2021) Guidance on Sustainability Linked Loan Principles, https://www.lma.eu.com/application/files/5416/2210/4826/SSLP_Guidance.pdf (archived at https://perma.cc/D2PG-ALN9) 58 Real Estate Capital Europe (2016) Lloyds completes first loan using £1bn ‘green’ lending fund, https://www.recapitalnews.com/lloyds-completes-first-loan-1bn-green-lending-fund/ (archived at https://perma.cc/GBY5-SUQJ) 59 Climate Strategy & Partners, and United Nations Environment Programme (2017) Green Tagging: mobilising bank finance for energy efficiency in real estate: Report from the Banking Work Group, https://hypo.org/app/uploads/sites/2/2018/03/Green_Tagging_ Mobilising_Bank_Finance_for_Energy_Efficiency_in_Real_Estate_3222151.pdf (archived at https://perma.cc/G9K9-QZEC) 60 World Trade Organization (2022) Trade finance, https://www.wto.org/english/thewto_e/ coher_e/tr_finance_e.htm (archived at https://perma.cc/NVJ5-8F2P) 61 CISL (2016) Incentivising the trade of sustainably produced commodities. A Discussion Paper prepared for the Banking Environment Initiative’s Sustainable Trade Finance Council, https://www.cisl.cam.ac.uk/system/files/documents/incentivising-the-trade-ofsustainably-produced.pdf (archived at https://perma.cc/CX8V-PSWD) 62 Ibid 63 DLL Group (2022) Sustainable Business Solutions, https://www.dllgroup.com/gb/en-gb/ about-us/sustainable-business-solutions (archived at https://perma.cc/7GQ3-VAFU) and https://www.dllgroup.com/en/resources/life-cycle-asset-management/second-life-financing (archived at https://perma.cc/R4T6-LAGP) 64 Westpac (2018) Westpac launches world’s first certified Green Tailored Deposit, https:// www.westpac.com.au/about-westpac/sustainability/news-resources-and-ratings/westpaclaunches-worlds-first-certified-green-tailored-deposit/ (archived at https://perma.cc/ C27A-RUMB)

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Green and sustainable bonds Introduction Debt capital (‘fixed income’) markets play a vital role in allocating capital to firms and projects tackling climate change, environmental and transition challenges. They can also help investors diversify and manage portfolio risk and integrate responsible and ethical investment approaches. Green and other forms of sustainable bond issuance have grown rapidly in recent years, exceeding $1.5 trillion in total by March 2022, including corporate, municipal and sovereign bonds, and an increasing array of bond types. As the market grows, so does the risk of greenwashing. Clear guidelines and frameworks for issuers and investors, including the Green Bond, Social Bond and Sustainability-Linked Bond Principles, help maintain market integrity and transparency.

L E A R N I N G OB J ECTI VES On completion of this chapter, you will be able to: ●●

●●

●●

●●

Describe the increasing range of green and sustainable bonds available to investors. Describe the main types and features of green and sustainable bonds, including green sukuk. Explain what is meant by the Green Bond, Social Bond and SustainabilityLinked Bond Principles, and the Sustainability Bond Guidelines, and how these and other frameworks, standards and guidelines support the development of the green and sustainable bond market. Describe how securitization may be used to support smaller green and sustainable finance projects and help these grow and develop.

Green and sustainable bonds

Introduction to debt capital Debt capital (often called ‘fixed income’, because investors receive agreed interest payments from borrowers) includes a wide range of bonds and other asset-backed securities. The terms ‘debt capital markets’ and ‘fixed income markets’ are used to describe the business of issuing, managing and trading in these. Institutions wanting to raise long-term finance might issue bonds to secure investment without diluting share holdings and without having to repay the principal for many years, possibly decades. In many jurisdictions, debt financing is often cheaper than equity financing due to the favourable tax treatment of debt. Investors provide capital by buying bonds and securities to generate a return, offset liabilities and diversify portfolios (geographically, across economic sectors or in terms of risk profile). Debt products fall into two main categories: 1 Organization-guaranteed (‘use of proceeds’) bonds, which raise money for general purposes and are backed by the issuing organization as a whole. Government (sovereign) bonds, municipal bonds and corporate bonds are the main types by issuer (other issuers include multilateral organizations such as the World Bank). Use of the money raised (proceeds) by these bonds may be linked to certain qualifying assets or purposes – as we shall see below, this is the case in terms of green and sustainable bonds. 2 Asset-backed securities, where interest payments are tied directly to specified assets such as a solar energy project. Such assets are often placed in a corporate structure called a ‘special purpose entity/vehicle’ set up with the specific purpose of holding the assets. There are also a wide variety of hybrid structures where lenders have recourse to the income from assets and from the issuing company, as well as convertible bonds, which can be turned into equity when certain conditions are met. These are less common in respect of green and sustainable finance and are not covered in this course. Overall, bonds are the largest single asset class in the financial system, with nearly $130 trillion of total issuance outstanding, according to the International Capital Markets Association (2020).1 Key features of bonds include: ●●

●●

●●

Issuer risk: How likely is it that the borrower (for example, a company or a government) will default (i.e. not pay back the principal or interest due on the bond)? Currency risk: Bonds can be issued in many currencies, and fluctuations in exchange rates may affect their existing and future value to international investors. Coupon: The rate of interest paid on the face value of the bond (usually paid annually, semi-annually or quarterly). The higher the risk of default, the higher the interest or coupon needed to compensate investors for taking on that risk.

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Maturity: How long is it before the investor gets their money back? The further into the future the maturity date (and hence, the longer the term of the bond), the greater the risk. Some bonds are issued in perpetuity, with no maturity date. Yield: The investment return on a bond, calculated by dividing the coupon by the current market price. As bond prices increase, the yield falls. When bond prices fall, the yield increases. When interest rates fall, bond prices usually rise (to make holding a bond more attractive) – there is an inverse relationship between bond prices and interest rates.

Unlike equity investors, bond investors do not have voting rights or the opportunity to participate in the growth of a company or asset. Conversely, bond holders are not exposed directly to a fall in the stock market value of a company, and they have an earlier call on assets if a company does get into trouble and goes into default (in general, bank loans have first call, then bond holders and finally shareholders).

QUICK QUESTION Why might a company choose to raise finance for new green and sustainable projects by issuing bonds, rather than other sources of capital?

Debt is particularly suited for financing the substantial investment costs of many green and sustainable projects, particularly those involving renewable energy such as wind or solar. This is due in part to its suitability for projects with large upfront costs that generate relatively stable and predictable returns over a lengthy period of time. Debt, therefore, plays a considerably more important role in financing renewable energy infrastructure projects than equity capital does. The IEA (2019), for example, found that renewable energy project finance in 2018 typically exhibited an 80/20 ratio of debt to equity.2 For most renewable energy projects, the majority of project costs are incurred upfront (e.g. during the construction of a solar array or an offshore windfarm). Ongoing, marginal costs are low, as the sun shines and the wind blows for free – although there will be ongoing maintenance, transmission and other costs. This contrasts with traditional power generation projects, where ongoing marginal costs are high relative to construction costs due to owners and operators having to pay for continued fossil fuel inputs from volatile commodity markets including oil, gas and coal. As we have seen in earlier chapters, the introduction of more realistic and consistent global carbon pricing should see the cost of such inputs rise.

Green and sustainable bonds

Although risk profiles differ considerably between different clean technologies and geographies, the typical ‘green’ project lifecycle is characterized by higher levels of risk in the development and construction phases due to technology and construction risks. Political and regulatory risk may also be a factor (for example, if subsidies for renewable energy are reduced or eliminated). Risk levels tend to decrease once a project becomes operational and is producing predictable, stable cash flows to service debt and generate returns, although there are of course issues relating to the variability of sun, wind and tidal energy. In general, though, renewable energy infrastructure projects face a higher cost of capital in the development and construction phases (capital expenditure – capex) and a lower cost of capital when operational (opex). This transition from opex-based systems (i.e. relatively small, upfront capital costs followed by high, variable resource input costs) to capex-based ones (i.e. high, upfront capital costs followed by relatively small marginal costs) is a fundamental change in how we need to think about economics, project returns and finance in the context of green and sustainable finance. It is not only relevant to large infrastructure projects such as the examples given above, but to many areas of retail finance, too, such as the purchase of an electric vehicle, where relatively high purchase costs are offset by low running costs.

QUICK QUESTION Can you think of other examples in green finance where high capital costs (capex) are followed by relatively low operating costs (opex)?

Green bonds Introduction to green bonds The emergence of green bonds (and the more recent evolution of a wider range of sustainable bond types) has been one of the key developments in green and sustainable finance in recent years. Green bonds are designed to improve the ability of debt capital markets to raise capital to finance solutions to climate change, environmental, social sustainability and transition challenges, while also offering investors an opportunity to share in financial returns available from the transition to a more sustainable, low-carbon world. Green and other types of sustainable bonds can also help investors diversify and manage risk in their portfolios and integrate responsible and sustainable investment approaches. They have the further advantage of allowing governments and other issuers to support the flow of capital to priority sectors to achieve public policy and other goals, including climate change mitigation and adaptation.

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Green bonds are those where the proceeds raised are allocated to environmental projects or uses. They might be used to raise capital for a wide variety of purposes, including, but not limited to, renewable energy projects, clean transport infrastructure, sustainable buildings, flood defences, or sustainable forestry and agriculture. Following 10 consecutive years of growth, total green bond issuance reached a record $523 billion in 2021, according to the Climate Bonds Initiative, which tracks the issue of green bonds. Other types of sustainable bonds (which we introduce and explore below) – including social, sustainability and transition bonds – accounted for nearly $650 billion of issuance during the year, with the rapid growth of the market in recent years explained in part by the issue of pandemic bonds in response to Covid19.3 Despite total sustainable bond issuance of approximately $1.1 trillion in 2021, we should remember that this is still a relatively small proportion of the $9–$10 trillion of overall issuance during the year. Total issuance of green and sustainable bond types accounts for less than 5 per cent of total global bond issuance outstanding (approximately $120 trillion), so despite the rapid growth in recent years there is still a long way to go before green and sustainable debt can be described as mainstream. Often summarized as ‘transparency’ (in terms of use of proceeds and disclosure of impacts) and ‘ring-fencing’ (to ensure that funds are used for environmental purposes only), there are four generally agreed aspects to green bonds that differentiate them from normal, ‘vanilla’ bonds (which we explore in more detail in relation to the Green Bond Principles below): ●●

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Use of proceeds: Green bonds should be used to finance projects with environmentally positive outcomes, such as an offshore wind farm or clean transport. External review: The issuers of a green bond should evaluate the intended environmental sustainability objectives of projects with the help of a suitably qualified external reviewer. Disclosure and management of proceeds: The allocation of funds raised from a green bond should be independently audited and disclosed to investors and others. Reporting: Issuers should report on the environmental impacts achieved – both positive and negative.

Some green bonds carry a recognized label and/or certification that enables investors to better understand how the proceeds are used, while others may be marketed as ‘green’ but not carry a specific label (this may or may not indicate a lesser degree or quality of environmental benefit). As the green bond market grows, there is an increasing risk of greenwashing, where financial instruments are marketed as ‘green’, but the projects they support are not widely recognized as such (for example, supporting power generation using ‘cleaner coal’). The development of market and regulatory frameworks, standards and guidance for issuers and investors, such as the Climate Bonds Standard developed by the Climate Bonds Initiative, the Green Bond

Green and sustainable bonds

Principles, the EU Taxonomy and the forthcoming EU Green Bond Standard, along with similar national and organizational frameworks, will play important roles in maintaining market integrity and transparency. The majority of green bonds issued to date are green ‘use of proceeds’ bonds. This is where the capital raised is used for specific climate change mitigation and/or adaptation projects, and the bonds are backed by the issuer’s entire balance sheet – known as a ‘recourse-to-the-issuer debt obligation’. This gives confidence to investors and rating agencies by significantly reducing (in most cases) the credit risk and risk of default. Importantly, this approach encourages similar pricing of both green and conventional ‘vanilla’ bonds from issuers, where there is no premium charged for the former. There are a wide and growing range of issuers of green ‘use of proceeds’ bonds, and green bonds in general, including: ●●

●● ●●

sovereigns (i.e. countries – bonds issued by a recognized government and backed by its credit rating); municipalities (i.e. regions and cities); multilateral and national development banks, and similar development finance institutions (e.g. the World Bank, the European Investment Bank);

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financial institutions; and

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corporate issuers.

In the case study below, we describe a typical green ‘use of proceeds’ bond.

CASE STUDY A green ‘use of proceeds’ bond – BNP Paribas4 In October 2020, BNP Paribas issued €750 million, seven-year fixed to floating rate senior non-preferred notes, with the use of proceeds financing or refinancing eligible, environmentally sustainable assets as defined by the bank’s Green Bond Framework, which is aligned to the Green Bond Principles. This issue, therefore, can be described as a ‘green bond’. Key features of the issue are: Specified currency: EUR Tranche: €750,000,000 Face value: 100,000 Coupon: €375

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Issue date: 14 October 2020 Maturity date: 14 October 2027 Interest basis: Initially 0.375 per cent per annum fixed rate to the Optional Redemption Date of 14 October 2026 Three-month EURIBOR + 0.8 per cent floating rate from the Optional Redemption Date to maturity Lead manager: BNP Paribas Joint managers: Banco Bilbao, Commerzbank, Danske Bank, SEB, Swedbank Expected ratings: Baa1 (Moodys), A- (S&P), A+ (Fitch), A (DBRS) Use of proceeds: Financing and/or refinancing eligible green assets in the categories of: ––

Renewable energy

––

Energy efficiency

––

Green buildings

––

Transportation

––

Water management and water treatment

––

Pollution prevention and control

The eligible green assets are further defined in BNP Paribas’ Green Bond Framework. A second-party opinion has been obtained from ISS ESG to confirm the alignment of the Framework with the Green Bond Principles. EY acts as the independent verifier for (i) compliance of the green assets selected for the green bonds with the Framework, (ii) impact reporting and (iii) management of the net proceeds.

Green project bonds differ in that they are not backed by an issuer’s whole balance sheet, but by the green project’s or projects’ assets and balance sheet(s) only. Generally, there is no recourse to the issuer, which increases the risk profile of the bond – in some cases very significantly – making green project bonds less attractive to investors, who will therefore require a higher return to compensate for the higher risk. For this reason, many project bonds are issued, supported by and/or underwritten (in whole or in part) by national and multilateral development banks with a mandate to operate in areas of the market that commercial issuers and underwriters might find unattractive. A common, credit-enhancing support tool used by development banks is ‘first loss provision’. This is where a bond’s risk-return profile is improved by a guarantee

Green and sustainable bonds

to underwrite losses, with the aim of ‘unlocking’ private capital to invest alongside the development bank. The role of development banks is covered in more detail in the next chapter. Green revenue bonds are backed by a project’s pledged revenue streams, usually with no recourse to the issuer. As with project bonds, these tend to be riskier than ‘use of proceeds’ bonds, because revenue streams may be uncertain. In 2016, for example, New York’s Metropolitan Transportation Authority (MTA) issued a $500 million revenue bond to finance improvements to public transport, backed by the revenues from the MTA system. Public transport revenues fell substantially in 2020 and 2021 because of Covid-19, increasing the risk of deferred payments and default to bondholders. Other types of green bonds include green convertible bonds (where debt can be converted into equity of the issuer) and green exchangeable bonds (where debt can be converted into equity of an entity other than the entity, although usually related to it). Whilst it is important to know that these different types of green bonds exist, for the purpose of this book we will not examine them in any detail.

QUICK QUESTION Has the country where you live and/or work issued any green bonds, or have there been any issues from companies or others?

The development of the green bond market Initially, the development of green bonds was led by international financial institutions, including the International Finance Corporation (IFC) – the World Bank’s private sector lending arm – and multilateral development banks including the European Investment Bank (EIB) and the European Bank for Reconstruction and Development (EBRD). The EIB issued the first recognized green bond in 2007 (referred to as a ‘Climate Awareness Bond’); as of 2020, the EIB’s green bond portfolio had grown €33.7 billion in 17 currencies, supporting 266 projects in 57 countries.5 The World Bank issued the first security to be referred to as a ‘green bond’ in 2008.6 The green bond market has developed rapidly since 2007/08. According to the Climate Bonds Initiative (CBI), to the end of 2021 a cumulative total of 2,045 issuers from 80 countries had issued 9,986 green bonds, not including other categories of social and sustainable bonds.7 Following more than a decade of growth, as we noted above, annual issuance of all green, social and sustainable bond types grew to $1.1 trillion in 2021, an increase of 46 per cent from the previous year.8 Green bond issuance totalled $523 billion in 2021, an increase of 75 per cent from the 2020 total

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of $298 billion. According to the CBI, the United States was the leading issuer in the global green bond market in 2021, with approximately $80 billion of issuance, and is by some margin the global leader in terms of total green bond issuance to date. China ranked second, with nearly $70 billion of issuance, and Germany third, with approximately $63 billion of issuance.9 The diversity of issuers, investors and types of green bonds continues to grow year on year, and the size of issues and longer bond maturities (lengths) have also increased as the green bond market has matured. A notable development in recent years has been the growth in sovereign issuers, with G7 countries including Germany, France, Korea, Sweden, Spain and the UK joining emerging markets issuers such as Chile, Fiji, Serbia and Uzbekistan. France, Germany and the UK are the largest sovereign green bond issuers, with the UK’s £10 billion ($13.7 billion) ‘Green Gilt’ the largest green bond issued in 2021.10 The European Union has also begun to issue sovereign green bonds, with its €12 billion issue in October 2021.11 According to the Climate Bonds Initiative, the majority (81 per cent) of green bonds’ use of proceeds in 2021 were allocated towards renewable energy, low-carbon buildings and low-carbon transport.12 As the global green bond market has grown and developed, related products and services have appeared, including stock market listings, indices, green bond funds, index funds and ETFs. We explore these in more detail later in this chapter. The growth of such related products and services improves the visibility of green and sustainable bonds to investors, encourages secondary market trading and develops a wider investment base and a deeper pool of capital. National green and sustainable bond markets provide an additional source of long-term green and sustainable finance to bank lending and equity finance, as well as funds for governments, regions and municipalities to invest in green infrastructure and projects. This is especially valuable in countries where demand for green and sustainable investment is high, but the supply of long-term bank loans and project or equity finance is limited. Successful bond markets are dependent on well-developed capital markets and supporting infrastructure, which are not always present in all countries. Examples of developing green (and sustainability) bond markets are found in Table 7.1.

QUICK QUESTION Research the green bond market in the country where you live or work, or a country you know well. What have been the latest developments and issues from sovereigns, state entities and others?

Green and sustainable bonds

Table 7.1  Examples of developing green bond markets Country

Overview of developments

Australia

Issued in 2014 by the World Bank, the first Australian green bond was an AU $300 million five-year bond. In 2016, the state of Victoria issued the world’s first sub-sovereign Certified Climate Bond, an AU $300 million issue with the proceeds financing investments in transport, renewable energy, water and low-carbon buildings.13 National Australia Bank (NAB) has been a pioneer in the market; it issued the country’s first Certified Climate Bond in 2014, and the first securitized residential mortgage-backed green bond financing low-carbon homes in 2018.14 By 2021, the green bond market had grown to some AU $15.6 billion, according to Westpac.15

Brazil

The Brazilian National Bank for Economic and Social Development (BNDES) published its green bond framework in 2017, supplemented in 2021 by the publication of its sustainability bond framework covering green, sustainability and social bonds.16 BNDES issued Brazil’s first green bond in 2018, a $1 billion, seven-year issue to fund new and existing solar and wind power generation projects. According to the Climate Bonds Initiative, Brazil is now (as of 2021) the largest green bond market in Latin America, with $10.3 billion of total issue from 78 issues and 44 issuers.17

Chile

Chile’s Green Bond Framework was published by the Ministry of Finance in 2019,18 and in the same year Chile became the first country from the Americas to issue green bonds on the London Stock Exchange – a $1.42 billion, 30-year bond followed by a €861 million, 12-year bond.19 According to the Climate Bonds Initiative, Chile led South America in the issue of green, sustainability and social bonds to the end of 2021, with nearly $18 billion raised from 33 bond issues from 16 issuers, approximately half of which are green bonds.20

China

China has been developing its green bond market since 2015, when it issued its first national green bond guidelines. The People’s Bank of China, the China Securities Regulatory Commission and other authorities have published a range of guidance, culminating in 2020 with the Green Bond Endorsed Project Catalogue, revised in 2021, which sets out definitions for green bond use of proceeds (see below for more details).21 The green bond market has grown rapidly in China, with some $56 billion and $44 billion of total issuance in 2019 and 2020 respectively, and with major issuers including government-backed entities (local governments and water authorities), corporates and financial institutions.22 Total issuance is forecast to exceed $100 billion in 2022.23 (continued)

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Table 7.1  (Continued) Country

Overview of developments

France

France has been in the forefront of the developing green bond market, and a leading issuer of green bonds since its first three municipal green bonds were issued in 2012. There have been a wide range of issues from financial institutions, corporates and government/local government entities since then. France was the second country to issue a sovereign green bond, a €7 billion, 22-year issue in 2017 followed by several subsequent issues, making France the leading issuer of sovereign green bonds as of 2021, with some €34 billion of total issuance. The Paris-based stock exchange, Euronext, lists a wide range of European-issued green bonds.24

Germany

Since the issue of the country’s first green bonds (by regional banks) in 2013, the German green bond market has grown rapidly, to rank second only to the US in 2021 with slightly over $60 billion of issuance of green and other types of sustainable bonds in the year.25 This is due to Germany’s position at the heart of the EU, and to a favourable policy environment in terms of supporting the development of renewable energy, establishing Germany as a global centre for green and sustainable finance. The German development bank KfW (see Chapter 8) has been one of the largest issuers of green bonds to date. In 2020, Germany launched its first sovereign green bond, a €6.5 billion 10-year issue followed by a €4.6 billion five-year bond. Issuance of sovereign green bonds totalled €12.5 billion in 2021, and is planned to grow further in 2022 and beyond. The German government has adopted a policy of issuing ‘twin bonds’ – a green bond and a vanilla ‘twin’ are issued concurrently, with the same characteristics, identical in maturity and coupon.26

India

According to the Climate Bonds Initiative, India is the fastest-growing market for green and other types of sustainable bonds in the Asia-Pacific, with a total issuance to the end of 2021 of $19.5 billion and a record $6.4 billion of issuance in that year. Approximately 75 per cent of green bonds have been issued by the private sector, with the great majority to date being used to fund renewable energy projects.27 The country’s first issue of sovereign green bonds is planned for 2022.

Japan

With its well-developed capital markets, Japan has been a leader in Asia in the issue of green bonds. The first Japanese green bond was issued in 2014 by the Development Bank of Japan. National Green Bond Guidelines were published by the Ministry of the Environment in 2017, and revised in 2020 to align with the Green Bond Principles and to include guidance for green and sustainability-linked loans.28 The Ministry of the Environment has also developed a Green Bond Issuance Promotion Platform, which collates information on the issuance of green bonds.29 To the end of 2020, cumulative green bond issuance totalled more than $26 billion, with issuers including government-backed entities such as the Japan Housing Finance Agency and Japan Railway, financial institutions and large corporates.30 (continued)

Green and sustainable bonds

Table 7.1  (Continued) Country

Overview of developments

Mexico

In 2017, Nacional Financiera (the Mexican Development Bank) issued the country’s first recognized green bond, a $500 million, five-year issue. In 2018, the Mexican Green Bond Principles were published.31 To the end of 2021, a total of 21 green bonds have been issued by 12 issuers, with total issuance of $4 billion.32

Singapore

To support its ambition to become a leading regional and global centre for green and sustainable finance, Singapore has prioritized growing the green bond market. The Monetary Authority of Singapore (MAS) established a Sustainable Bond Grant scheme in 2017 to encourage the issue of green bonds and reduce the cost to issuers,33 following which some $5 billion of green and other types of sustainability bonds were issued in 2019 and 2020.34 In 2021, the National Environment Agency became the first Singaporean government agency to issue green bonds. The Singaporean government has announced plans to publish a national green bond framework and issue the country’s first sovereign green bonds in 2022, with some $35 billion of issue planned by 2030.35

South Africa

South Africa issued the first recognized green bond in Africa in 2012, a ZAR 5 billion, 14-year issue from the Industrial Development Corporation. Since then, the green bond market has grown slowly, with total issuance of approximately $2 billion to the end of 2020, with issuers including government-backed entities, municipalities and, increasingly, financial institutions. In 2021, the Development Bank of Southern Africa published a green bond framework,36 followed by the issue of its first green bond later that year, and plans to significantly increase issuance. Whilst the South African green bond market is relatively small in global terms, it is by far the most successful market in Africa in terms of total issuance and the number of issuers, and may catalyse the growth of markets in the region.

Sweden

Sweden is the largest Nordic market for green and other types of sustainable bonds, and one of the largest global markets, too, with cumulative issuance of more than $43 billion to the end of 2020 and total issuance in that year of $14.4 billion, according to the Climate Bonds Initiative.37 Local governments and housing associations are major issuers, with funding often being used to finance low-carbon buildings and transport. In 2020, the Swedish Ministry of Finance published a framework for sovereign green bonds, followed later in the year by the issue of an SEK 20 billion, 10-year bond.38

UK

In September 2021, the UK raised £10 billion from the sale of its first ‘Green Gilt’ (sovereign green bond),39 followed by a second £6 billion issue one month later with a 32-year maturity, making it the sovereign green bond with the longest maturity in the world.40 Issues are supported by the UK Government’s ‘Green Financing Framework’, published in June 2021.41 (continued)

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Table 7.1  (Continued) Country

Overview of developments

United States

The Biden Administration has announced ambitious plans to pour $2 trillion into green and sustainable finance – double the EU’s planned spending. Whilst there are rumours of an inaugural US sovereign green bond, nothing has materialized at the time of writing. As we noted above, though, the US is the largest country of issue of green bonds, as a result of regular issues from municipalities and government-sponsored enterprises, including the mortgage securitization organizations Fannie Mae and Freddie Mac.

The Green Bond Principles As outlined above, progress achieved in developing the green bond market to date has been rapid and substantial. Challenges to further scaling up of the green bond market remain, however, including those of developing credible, verifiable and generally accepted market standards, and increasing awareness and understanding of the market. As the green bond market develops, so does the risk of greenwashing, as issuers seek to take advantage of investor demand for issues labelled as ‘green’. In order to improve transparency and disclosure, promote integrity and support the development of the green bond market, the International Capital Markets Association (ICMA) developed the Green Bond Principles (GBPs), first published in 2014, revised in 2018, and whose latest version was released in June 2021.42 Although they are voluntary process guidelines, the GBPs have been widely adopted by issuers, investors and other market participants. Although formally a bond does not need to be aligned with the GBPs to be described as a ‘green bond’, the Principles have become a generally accepted market standard in most major jurisdictions, and are referenced in or used as the basis for many national regulatory frameworks and guidance. The GBPs aim to: ●●

●●

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provide issuers with guidance on the key components involved in launching a credible green bond; aid investors by ensuring the availability of the information necessary to evaluate the environmental impact of green bond investments; and assist underwriters by moving the market towards standard disclosures that will facilitate transactions.

The GBPs recommend a clear process and disclosure for issuers, which investors, banks, investment banks, underwriters, placement agents and others may use to understand the characteristics of any given green bond. They set out appropriate

Green and sustainable bonds

levels of transparency, accuracy and integrity of information disclosed and reported by issuers to stakeholders. There are four core components: 1 Use of proceeds The cornerstone of a green bond is the utilization of the proceeds of the bond for green projects, which should be appropriately described in the legal documentation for the bond. Green projects should provide clear environmental benefits, which will be assessed and, where feasible, quantified by the issuer. Eligible green projects should contribute to one or more high-level environmental objectives, defined in the 2021 revision of the GBPs as climate change mitigation, climate change adaptation, natural resource conservation, biodiversity conservation and pollution prevention and control. The GBPs also contain an indicative list of project categories building on these, but recommend that issuers refer to taxonomies and similar classifications to determine eligibility. 2 Process for project evaluation and selection The issuer of a green bond should clearly communicate: (a) the intended environmental objectives of eligible green projects, (b) the process by which the issuer has determined eligibility, and (c) information on the social and environmental risks associated with the eligible green projects. In addition, issuers are encouraged to position this information within their broader sustainability strategy, to provide information on the alignment of eligible green projects with taxonomies and similar classifications, to report any relevant environmental standards or certifications and to put processes in place to mitigate any material risks of social or environmental impacts from the projects. 3 Management of proceeds The net proceeds of green bonds should be credited to a sub-account, moved to a sub-portfolio or otherwise tracked by the issuer in an appropriate manner and attested to by a formal internal process linked to the issuer’s lending and investment operations for green projects. Whilst green bonds are outstanding, the balance of the tracked proceeds should be periodically adjusted to match allocations to eligible green projects made during that period. The issuer should make known to investors the intended types of temporary placement for the balance of unallocated proceeds. The GBPs encourage a high level of transparency and recommend that the management of proceeds should be supplemented by the use of an auditor or other third party to verify internal tracking and the allocation of funds from the green bond proceeds. This external review has become a ‘Key Recommendation’ in the 2021 revision of the GBPs (see below). 4 Reporting Issuers should make, and keep, readily available, up-to-date information on the use of proceeds, to be renewed annually until full allocation and as necessary

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thereafter in the event of new developments. This should include a list of the projects to which green bond proceeds have been allocated, as well as a brief description of the projects and the amounts allocated, and their expected impact. Where confidentiality agreements, competitive considerations or a large number of underlying projects limit the amount of detail that can be made available, the GBPs recommend that information be presented in generic terms or on an aggregated portfolio basis (for example, the percentages allocated to particular project categories). Transparency is of particular value in communicating the expected impact of projects. The GBPs recommend the use of qualitative performance indicators and, where feasible, quantitative performance measures, with the key underlying methodology and/or assumptions used in the quantitative determination disclosed alongside these. The 2021 revision of the GBPs encourages issuers to use, where possible, the ICMA’s ‘Harmonised Framework for Impact Reporting’.43

Key recommendations The most recent (2021) version of the Green Bond Principles also includes two ‘Key Recommendations for Heightened Transparency’ relating to (a) Green Bond Frameworks, and (b) External Reviews: ●●

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Issuers should explain the alignment of their green bond(s) with the four core components of the GBPs (summarized above) in a Green Bond Framework or similar standard. Ideally, this should also include information about the issuer’s overall Paris alignment/broader sustainability strategy, and issuers are encouraged to disclose any taxonomies, standards or certifications referenced in project selection. In other words, issuers are expected to be as transparent as possible and to provide as much relevant information as possible regarding disclosures, so that investors and others can have confidence in the environmental credibility of the issue. Issuers are advised to obtain third-party external reviews, both pre-issuance (to ensure alignment of the Green Bond(s) with the four core components of the GBPs) and post-issuance (to verify the allocation of funds to eligible green projects).44

The wide market acceptance of the GBPs since their publication in 2014 has certainly helped promote consistency, transparency and market integrity. Their status as voluntary, best practice guidance rather than formal, regulatory standards means that there may, however, be some inconsistency in their application. In particular, the GBPs have been criticized for a lack of detail as to what constitutes a ‘green’ project that can be financed by the proceeds of a green bond – in other words, for providing a broad range of project categories supporting environmental sustainability without the level of detail necessary to fully determine their benefits. The 2021 version of the GBPs, however, recommends that issuers refer to taxonomies (and disclose alignment with these); it makes more sense to direct issuers to these rather than develop a new taxonomy or other classification specifically to support the GBPs.

Green and sustainable bonds

Despite these criticisms, the Green Bond Principles have undoubtedly brought greater consistency, integrity and transparency to the green bond market, and have helped support its growth and development. They have also been used as the basis for a range of similar voluntary process guidelines for other types of green and sustainable bonds, including: ●●

the Social Bond Principles

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the Sustainability-Linked Bond Principles

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the Sustainability Bond Guidelines

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national and institutional green and sustainable bond frameworks and guidance

The Social Bond and Sustainability-Linked Bond Principles, and the Sustainability Bond Guidelines, are covered in more detail later in this chapter. Many financial institutions and corporates have also developed their own frameworks for issuing green, social and sustainability bonds. For example: ●●

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NatWest’s Green, Social and Sustainability Bond Framework,45 which supports the bank’s enhanced strategic focus on climate transition and supporting enterprise. The Framework explicitly references the Green and Social Bond Principles and the Sustainability Bond Guidelines, and sets out eligible use of proceeds for green and social bonds. The Framework was independently reviewed by Sustainalytics. The NatWest Framework is examined in more detail in the case study in the next section. EDF’s updated (2020) Green Bond Framework,46 revised and enhanced since EDF issued its first green bonds in 2013, which at that time were dedicated to the construction of new wind and solar installations. The Framework is aligned to the Green Bond Principles and the proposed EU Green Bond Standards (although the latter are not yet finalized). In the updated Framework, eligible use of proceeds has been widened to include renewable power generation, investments in existing hydropower facilities, investments in energy efficiency, and biodiversity protection. Vigeo Eris was appointed to independently review the Framework.

We examine some examples of other green bond frameworks in the next section.

QUICK QUESTION Obtain the green bond framework for your institution (if applicable) or an institution with which you are familiar. What eligible uses of proceeds are specified?

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READING How green is a green bond?47 The Green Bond Principles (GBPs) are a set of voluntary process guidelines that make recommendations on transparency, disclosure and reporting for market participants in order to promote integrity in the market and enable its development. They provide a flexible approach – which has been criticized by some for failing to exclude the use of proceeds for projects of questionable environmental benefit or sustainability. A €500 million green bond issued by Repsol Energy in 2017, for example, fits within the GBPs eligible project categories, but was not viewed as ‘green’ by some investors because the proceeds finance energy efficiency improvement to oil and gas refineries. Whilst the energy efficiency gains would reduce direct CO2 emissions by an estimated 1.2 million tonnes annually by 2020, this is a relatively small fraction of Repsol’s total direct emissions of nearly 20 million tonnes in 2016, and does not account for the much more significant Scope 3 (indirect) emissions. It does not, therefore, the argument goes, make a significant contribution to the ‘greening’ of Repsol or to the objectives of the Paris Agreement. The issue would not be certified under the stricter Climate Bonds Standard, and was not included within green bond indices. The issue attracted much commentary in the financial press as an example of potential greenwashing. This is probably unfair, as Repsol provided clear disclosure on the use of proceeds, and the issue was externally reviewed in line with the GBP requirements. There was no intention to market the issue as anything it was not. But is this really a ‘green bond’? This example illustrates the challenge of trying to establish frameworks, guidance and standards for a new product or asset class like green bonds. There is a risk of confusion among investors, and of frustration and negative publicity from market participants and others where it is felt these are used – deliberately or inadvertently – in a misleading manner, or in a way that allows projects and products that meet less stringent criteria to compete with others that adhere to more rigorous requirements. There is a risk of misallocation of capital, as well as a risk to the credibility of particular bond issues and to the green bond market as a whole.

Other green bond frameworks Apart from the Green Bond Principles, many countries, regions and organizations have developed their own green bond frameworks and similar standards, which are

Green and sustainable bonds

often aligned with and/or directly reference the Green Bond Principles. In this section, we examine several of these.

The EU Green Bond Standard As we described in earlier chapters, the European Union (EU) has published an EU Taxonomy for Sustainable Activities, and this has now come into force. It is a key part of the EU’s Action Plan: Financing Sustainable Growth, which also aims to: ●●

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introduce EU labels for ‘green’ financial products to help investors to easily identify investments that comply with agreed criteria, based on the EU Taxonomy; develop an EU Green Bond Standard, aligned with the Taxonomy and existing market standards such as the Green Bond Principles and Climate Bonds Standard;

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introduce benchmarks for low-carbon investment strategies; and

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improve guidance regarding corporate disclosure of climate-related information.

Given the EU’s scale and influence, and the launch of the ‘European Green Deal’ that sets out plans for a net zero target for the European Union by 2050, the implementation of the Action Plan is likely to bring significantly greater regulatory backing to existing, voluntary market standards by embedding them, or versions of them, in EU law. The proposed EU Green Bond Standard is intended to explicitly define what an ‘EU Green Bond’ is, and to enhance the transparency, integrity, consistency and comparability of such bonds. The proposals draw heavily on the Green Bond Principles; they contain the same four core components (use of proceeds, process for project evaluation and selection, management of proceeds, reporting). Independent review by an expert, external reviewer will also be required. Unlike the Green Bond Principles, the EU Green Bond Standard will have legal force. The EU Taxonomy will be used to determine what investments qualify as being environmentally sustainable in the context of the proposed EU Green Bond Standard. Once the Standard comes into force, for a bond issued in the EU to be described as a ‘green bond’ the use of proceeds will need to materially support at least one of the six categories of environmentally sustainable activities set out in the EU Taxonomy and the associated Technical Screening Criteria. Some bonds currently labelled ‘green’ may not meet these criteria, even though they do meet the requirements of the Green Bond Principles. As currently proposed (April 2022), the EU Green Bond Standard will be voluntary, although all issuers of green bonds in the EU would have to disclose how the use of proceeds aligns with the EU Taxonomy. Some, such as the EU Parliament’s Committee on the Environment, Public Health and Food Safety, and the Committee on Economic and Monetary Affairs, have called for the EU Green Bond Standard to

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become mandatory in order to bring greater rigour and standardization to the issue of green bonds in the EU.48

China’s Green Bond Guidelines Beginning in 2015, China established guidelines for green bonds as part of a wider programme to promote and expand green finance. Like other countries, China recognizes that traditional sources of capital are insufficient to meet the investment needs of the transition to a more sustainable, low-carbon economy, and is prioritizing the development of green bonds and the green bond market as a key tool for accessing capital from institutional investors. China is now one of the world’s largest green bond markets, with corporate and municipal issuance of approximately $17 billion in 2020. Concerns have been expressed, however, that this rapid rise in green bond issuance may lead to instances of greenwashing (although this is a challenge for all countries), hence the need for guidelines to ensure market consistency and integrity. In 2015, the People’s Bank of China (PBoC) issued its first guidelines defining criteria and use of proceeds for green bonds issued by financial institutions in its ‘Green Bond Endorsed Project Catalogue’. The Catalogue defined eligible green projects and provided guidelines for these in six environmentally sustainable areas. Separate ‘Green Bond Guidelines’ for domestic corporate bonds (non-financial issuers) were published by the National Development and Reform Commission (NDRC), and green bonds issued by listed companies and corporate asset-backed securities were subject to the China Securities Regulatory Commission’s (CSRC) ‘Guidelines for Supporting Green Bond Development’.49 All three sets of guidance contained broadly similar criteria for the issuance of green bonds, based on the Green Bond Principles: 1 Eligible green project categories The guidance broadly outlined the types of projects eligible for green bond funding, but used different criteria. For example, the NDRC Guidance identified 12 project categories, while the PBoC Catalogue outlined six. The PBoC provided more detail at the sub-sector levels of project classification and eligibility criteria within each of its six broad categories. 2 Management of proceeds All the guidelines established requirements for managing proceeds. 3 Requirements on information disclosure The guidelines differed in terms of the frequency and extent of reporting. The PBoC, for example, required reporting to be on a quarterly basis, with issuers disclosing detail on the use of proceeds in their annual report and a special auditor’s report. 4 Requirements for external review The guidelines did not require external review, but this was encouraged by the PBoC and CSRC. As a result, external reviews have become the norm.

Green and sustainable bonds

Having three similar, but not identical sets of guidelines for green bonds could cause confusion and add complexity to a developing market. In addition, the guidelines were criticized, especially internationally, for including cleaner coal and natural gas among the eligible uses of proceeds. More recently, the Chinese regulatory authorities have been working to develop a joint approach, as well as to harmonize with international frameworks and guidance. This resulted in the publication of a Green Bond Endorsed Project Catalogue in 2020 (revised in 2021), jointly developed by the PBoC, NDRC and CSRC, which covers all domestic green bond issues.50 The 2020 Catalogue classifies eligible green projects in six areas: ●●

energy saving and environmental protection industry

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clean production industry

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clean energy industry

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ecology and environment-related sectors

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sustainable upgrade of infrastructure

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green services

The six high-level categories are subdivided into 25 second-level sub-categories, which are further subdivided into third- and fourth-level sub-categories, giving a considerable level of detail as to eligible projects. The 2020 Catalogue excluded coal and natural gas, but the 2021 revision now includes gas and nuclear (as does the EU Taxonomy).

QUICK QUESTION Why might China be keen to align its green bond guidance with international standards, frameworks and guidance?

The European Bank for Reconstruction and Development (EBRD) The EBRD was founded in 1991 and is owned by 71 countries and the European Community and European Investment Bank. Its mandate, via providing project finance mainly to the private sector, is to: ●●

●●

promote a transition to open, market-based economies in more than 30 countries from Central Europe to Central Asia and in the Southern and Eastern Mediterranean; apply sound banking principles, ensuring that project returns are commensurate with risk;

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finance projects that would not otherwise be solely funded by commercial banks; and ensure that projects facilitate socially and environmentally sound development.

Since 2010, the EBRD has been issuing Environmental Sustainability Bonds (ESB). To December 2021, the bank had issued nearly 100 ESBs totalling €5.5 billion, in a wide variety of currencies. The ESB Framework is aligned with the Green Bond Principles, and proceeds are earmarked to support: ●●

energy efficiency

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renewable energy

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water management

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waste management

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pollution prevention and sustainable transport

Internal review is conducted by the EBRD itself, with a second, external opinion obtained from Cicero. The EBRD applies a strict selection process to ESBs and excludes more universally accepted unsustainable activities such as gambling, pornography and tobacco. Exclusions also apply to many fossil fuel mining and energy activities, as well as those listed on the exclusion list of the EBRD’s Environmental and Social Policy. Positive selection is also undertaken, focusing on the environmental benefits of projects and activities – such as renewable energy, energy efficiency, or water and waste infrastructure.51 In 2019, the EBRD began to offer two new types of sustainable bonds: ●●

●●

Climate Resilience Bonds (CRB): These bonds are investments in climate change adaption. They are underpinned by the EBRD’s Climate Resilience Project Portfolio, which is consistent with the Climate Bond Initiative’s Climate Resilience Principles. To December 2021, the EBRD had issued €1.2 billion of CRBs, in 12 transactions. Green Transition Bonds (GTB): GTBs focus on improving key sectors of the economy that are dependent on fossil fuels. The bonds aim to finance their transition to low-carbon, resource-efficient alternatives. Similar to the CRBs above, GTBs are part of the Green Transition Project Portfolio, which focuses on manufacturing, food production and the construction and renovation of buildings. To December 2021, €1.2 billion of GTBs had been issued, in 13 transactions.52

Both the CRBs and GTBs have frameworks that are more niche and detailed than the more generic ESB framework.

Green and sustainable bonds

CASE STUDY NatWest Group: Green, Social & Sustainability Bond Framework53 In 2019, NatWest Group published its Green, Social and Sustainability Bond Framework, later updated in October 2020. Following the bank’s new purpose-led strategy under the leadership of CEO Alison Rose, the framework is one of several initiatives undertaken by the bank to meet its sustainability targets. It governs three types of bonds issued by NatWest Group: green bonds, social bonds and sustainability bonds. The Framework – developed in line with the Green Bond Principles, Social Bond Principles and Sustainability Bond Guidelines – aims to attract funding for loans and investments that lead to positive social and environmental impacts. It was created to provide a clear and transparent set of criteria to support the transition to a low-carbon economy. The NatWest Framework is made up of four key components: 1 Use of proceeds: This is the type of investment that can be considered. The framework focuses on eight key areas for funding: ❍❍ ❍❍ ❍❍ ❍❍ ❍❍ ❍❍ ❍❍ ❍❍

renewable energy pollution prevention and control green buildings clean transport SME lending female-owned business lending access to essential services affordable housing

2 Process for project evaluation and selection: A working group is responsible for evaluating projects, and there are several selection criteria. For example, to qualify as a green, social or sustainable bond, building loans must have an energy certificate performance of A or B, and must adhere to energy-saving processes. 3 Management of proceeds: The funds are managed at a portfolio level by the Group’s Treasury. 4 Reporting: NatWest Group publishes their bonds and framework publicly, so that they are transparent and open to scrutiny. In addition, the Framework also requires that the bonds and the Framework be regularly reviewed by an independent third party, Sustainalytics. This is to help provide objectivity and impartiality to the process.

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QUICK QUESTION Why might an issuer choose to issue a green bond rather than its vanilla equivalent?

Advantages and disadvantages of green bonds Given the growth of the green bond market in recent years as described above, issuers and others must receive – or at least perceive – benefits from the issuance of green bonds compared with traditional ‘vanilla’ alternatives. The commonly cited benefits and advantages of green bonds include: ●●

●●

●●

●●

They offer access to a more diversified investor base, including institutions and funds with environmental sustainability mandates, helping issuers raise capital. A survey of treasurers conducted by the Climate Bonds Initiative in 2020 found that 98 per cent of respondents said that the issue of a green bond attracted new investors.54 They provide reputational benefits to the issuer, demonstrating its commitment to environmental sustainability to policymakers, investors (and potential investors), employees, customers and others. Demand for green bonds tends to be higher than for traditional ‘vanilla’ alternatives. In the survey of treasurers noted above, 70 per cent of respondents said demand for their green bond was higher than for traditional equivalents. Throughout 2020, green bonds were oversubscribed compared with ‘vanilla’ bonds. There is emerging evidence of a ‘greenium’ – i.e. a premium for a green bond – compared with its ‘vanilla’ equivalents. The Climate Bonds Initiative analysed 33 green bonds issued in 2020, and found that 19 showed a greenium.55 This means that a bond is issued with a higher price (perhaps because of high demand) and therefore offers a lower yield.

There may also be several drawbacks to and potential disadvantages of green bonds. These include: ●●

●●

Green bonds are not necessarily additive, but are used to finance projects and activities by governments and organizations that, if they were economically justified, would happen anyway and could be funded through traditional bonds or other forms of finance. By focusing investment on generally new, ‘green’ technology and infrastructure, they do not support organizations’ overall transition to low-carbon business models. This can be overcome, however, through the use of new types of green bonds, such as transition bonds (described in the next section).

Green and sustainable bonds ●●

●●

The extra costs of issuing green bonds, because of the additional reporting and verification required, could potentially disincentivize investment in environmentally sustainable projects and activities (or at least lead issuers to use a traditional ‘vanilla’ bond for the same purpose). There is a risk of greenwashing where, because of the lack of strict market and regulatory standards, bonds may be marketed as ‘green’ but in fact support only marginal environmental benefits. This can lead to a misallocation of capital or jeopardize the credibility of the green bond market as a whole.

QUICK QUESTION In your view, would assets and projects being financed by green bonds have been successfully financed anyway?

Other types of green and sustainable bonds So far in this chapter we have referred primarily to ‘green bonds’, as though they are a single type of debt instrument. In fact, there are a wide range of green and sustainable bonds, with no single, formal definition of what a green and/or sustainable bond is (or is not). Generally, however, green bonds should: ●●

●●

be used to finance organizations, projects and activities with outcomes that benefit the environment (including, but not limited to, climate change mitigation and adaptation) and/or deliver social sustainability benefits; and be issued in accordance with a recognized standard or framework, such as the Green Bond Principles, Social Bond Principles, Climate Bonds Standard or Sustainability Bond Guidelines.

For the purposes of this book, when we refer to a green and/or sustainable bond we assume it has met these two criteria. As discussed in previous chapters, however, despite the recent publication of the EU Taxonomy for Sustainable Activities there is as yet no global standard or taxonomy defining exactly what is, or is not, ‘green’ and ‘sustainable’. Different countries and regions may (and do) adopt different definitions. Similarly, national green and sustainable bond standards, frameworks, definitions and guidelines may (and do) differ in their eligible use of proceeds. Furthermore, issuers do not – except where national regulation requires it – need to meet any such standards or guidelines, and

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can simply describe and market a bond as ‘green’ or ‘sustainable’, although this might be an egregious example of greenwashing. There are an increasing number of types of green and sustainable bonds in addition to the ‘green bonds’ described above. These are described below (in alphabetical order).

Blue bonds In October 2018, the Republic of the Seychelles issued the world’s first ‘blue bond’ to support sustainable marine and fisheries projects. Despite the small size of the issue ($15 million), this represented the beginning of an interesting new sector in the green and sustainable bond market. It reflects growing policymaker, issuer and investor interest in using finance to support marine conservation and biodiversity, often now referred to as ‘ocean finance’. The blue bond was pioneered by Nature Conservancy and the World Bank, and is best described as a ‘debt for seas swap deal’.56 A government, in this case the Republic of the Seychelles, pledges to protect important marine habitats under its jurisdiction, such as coral reefs. In exchange, the World Bank and other investors restructure outstanding sovereign debt, resulting in lower interest rates and annual payments to bondholders. The savings are ringfenced and used to support marine conservation, and to promote sustainable fishing and other similar measures. Following the issue of the first blue bond described above, use of proceeds bonds with features similar to those of green bonds have been issued by the Bank of China, the Nordic Investment Bank and the Asian Development Bank, among others. The Asian Development Bank has developed an ‘ADB Green and Blue Bond Framework’, which is closely aligned with the Green Bond Principles.57 As an emerging financial instrument, blue bonds may have a range of characteristics and there is, with the exception of the ADB’s Framework, no recognized set of principles or guidance setting out agreed use of proceeds and similar criteria. There is also nothing to prevent a green bond’s use of proceeds supporting marine conservation and biodiversity – in fact, many existing green bonds already do this.

Climate bonds ‘Climate bonds’ are a sub-category of green bonds where proceeds are used to finance projects specifically designed to mitigate or adapt to the effects of climate change. As we described above, green bond proceeds may be used to finance environmental projects more widely, not just for climate change mitigation and adaptation. In practice, many green bond proceeds are used to fund climate change projects, however, and the terminology is often used interchangeably.

Green and sustainable bonds

In this book, we use ‘green bond’ as our preferred terminology, except where the context or examples and case studies require specific reference to climate bonds. The Climate Bonds Initiative (CBI), introduced earlier in this chapter, has developed the ‘Climate Bonds Standard’ to provide assurance to investors (via certification) who want to be able to easily identify and invest in products that support action on climate change.58 A bond that meets the Climate Bonds Standard, including verification from an external, Approved Verifier, can be described as a ‘Certified Climate Bond’. There are four key aspects of the Climate Bonds Standard: ●●

identifying qualifying projects and assets, using the Standard’s eligibility criteria for low-carbon and climate-resilient projects and assets;

●●

arranging an independent review, and disclosing the results of that review;

●●

ensuring that the use of proceeds is tracked and reported, at least annually;

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having a robust and effective certification system in place.

The Standard is fully aligned with, but builds on, the Green Bond Principles described above by including detailed sector-specific criteria for projects and assets that may be certified by Approved Verifiers as supporting climate change mitigation and adaptation objectives. Criteria have been developed, or are being developed, for sectors including water, solar, wind, forestry, low-carbon buildings, bioenergy, geothermal energy, marine energy and low-carbon transport. The Standard is separated into pre-issuance requirements, which need to be met by issuers seeking certification ahead of issuance, and post-issuance requirements, which need to be met by issuers seeking continued certification following issuance. Investors benefit from certification by an Approved Verifier (overseen by the Climate Bonds Standard Board), and by not having to conduct their own, potentially costly and complex monitoring and verification of use of proceeds. Issuers benefit from being able to demonstrate the certified nature of the bond to potential investors. The green bond market overall benefits from enhanced consistency and integrity. The main differences between the Climate Bonds Standard and the Green Bond Principles are that the former provides more detailed Sector Criteria to define and describe eligible use of bond proceeds.59 These (together with other criteria) are set as requirements, rather than as principles, guidelines and recommendations as they are in the GBPs. The Climate Bonds Standard, therefore, sets a more rigorous standard for green bonds, but offers less flexibility to issuers.

QUICK QUESTION What are the costs and benefits of having more stringent standards and requirements in order to secure green bond labelling or certification?

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SDG/SDG-linked bonds As the name suggests, SDG and SDG-linked bonds are bonds where the use of proceeds is tied to achieving one or more of the UN Sustainable Development Goals (introduced in Chapter 1). Such bonds may, therefore, support climate change mitigation and adaptation activities, but also a wider set of environmental and social sustainability objectives. Some SDG bonds include a covenant that links the bond’s coupon to the issuer’s achievement of, or progress towards, agreed sustainability objectives, thereby incentivizing issuers in a manner similar to that of sustainability-linked loans as described in the previous chapter. A number of issuers have published their own SDG Bond Frameworks or similar standards to provide investors and others with more information on eligible use of proceeds and other key metrics. HSBC’s 2017 SDG Bond Framework, for example, sets out that use of proceeds may be linked with activities supporting: ●●

SDG 3 (Good Health and Wellbeing)

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SDG 4 (Quality Education)

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SDG 6 (Clean Water and Sanitation)

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SDG 7 (Affordable and Clean Energy)

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SDG 9 (Industry, Innovation and Infrastructure)

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SDG 11 (Sustainable Cities and Communities)

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SDG 13 (Climate Action)60

Other institutions, including the AFD (French Development Agency), Bank Sabadell, Telefonica and the Government of Mexico, have also published SDG Bond Frameworks. To bring greater consistency and comparability to SDG/SDG-linked bonds (and other categories of sustainability bonds) and to encourage the harmonization of issuers’ bond frameworks, the United Nations Development Programme (UNDP) has developed and published ‘SDG Impact Standards for Bonds’.61 The Standards are designed to promote sustainable development, advance the achievement of the SDGs, provide greater credibility and rigour to the issue of SDG bonds and fit in with existing principles, frameworks and tools whilst addressing gaps in current market practice. They are built around four interconnected and interdependent themes: 1 Strategy 2 Management approach 3 Transparency 4 Governance

Green and sustainable bonds

Each theme is supported by ‘practice indicators’ that set out in more detail what needs to be demonstrated by issuers to meet the standard.

Social bonds The term ‘social bond’ can refer to a variety of financial instruments used to fund projects aiming to achieve positive social – as opposed to environmental – outcomes, such as improvements in education, supporting female entrepreneurship or reducing recidivism. Whilst positive environmental outcomes may also be achieved, they are not the primary focus of the impact sought. The two main types of social bonds are: ●●

●●

‘Pay for performance’ contracts, usually between the public and private sectors, or between public sector and social enterprises, where a success payment is made on agreed social impact objectives being achieved and verified. These are not ‘bonds’ in the usual sense of a debt instrument, though they are often referred to as ‘social impact bonds’ (see below). To avoid confusion, this is how we will generally refer to this type of social bond. Impact bonds, structured in a manner similar to green bonds, except that proceeds are used to fund projects delivering positive social benefits. The International Capital Markets Association has published Social Bond Principles (updated in 2021); these are voluntary process guidelines for issuers of social bonds.62 Their approach is similar to that of the Green Bond Principles we examined in more detail above.

As an example of the latter, in early 2021 NatWest issued a €1 billion affordable housing social bond. Proceeds will be allocated to loans to not-for-profit housing associations that provide affordable rent, supported housing and shared ownership schemes. As we noted earlier in this chapter, social bond issuance increased significantly in 2020 and 2021 due to Covid-19, highlighting the links between social issues (such as education and poverty) and health. Issuance is expected to continue to increase to help fund the economic recovery. According to the Climate Bonds Initiative, a total of $201 billion of social bond issuance was recorded in 2021.63 Under its SURE programme – designed to finance short-term employment measures to counter the economic impacts of the pandemic – the European Union issued nearly €90 billion of social bonds between October 2020 and May 2021, and is the world’s largest issuer of social bonds.64

Social impact bonds As described above, social impact bonds are not ‘bonds’ as such, but rather ‘pay for performance’ contracts, where a success payment is made on agreed social impact objectives being achieved and verified. Such contracts are often used to seek and test

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alternative solutions to long-term social problems (such as addiction, unemployment) where traditional public policy approaches are not working. Impact investors – sometimes the public sector or public sector agencies, but also private sector impact investors and philanthropic organizations – fund the capital and operating costs of a project designed to achieve agreed social outcomes. Projects are often, although not always, delivered through social enterprise or other ‘third sector’ organizations. Investors receive their return via success payments made on the agreed social impact objectives being achieved and verified. According to Social Finance, as of March 2021 138 social impact bonds had raised a total of $441 million to support a range of social projects around the world, including workforce development, health, education, and child and family welfare.65 Compared with social bond issuance of more than $200 billion in 2021, however, this is a small and specialist part of the sustainable finance market.

Sustainability bonds ‘Sustainability Bonds’ combine aspects of green and social bonds, with the proceeds funding projects delivering a combination of environmental and social outcomes. Often, these are linked to the UN Sustainable Development Goals, and there is little difference in practice between Sustainability bonds and the SDG bonds described above, except that the latter specifically reference the SDGs and are now supported by the SDG Impact Standards. In 2018, the International Capital Markets Association (ICMA) published its ‘Sustainability Bond Guidelines’ to promote consistency, integrity and transparency in this category of bonds.66 These refer to the Green and Social Bond Principles also published by the ICMA, reflecting the fact that sustainability bonds combine green and social use of proceeds.

Sustainability-linked bonds As is the case with the SDG-linked bonds described above, sustainability-linked bonds seek to incentivize issuers to achieve environmental and social objectives, usually by varying the coupon. This may decrease by a predetermined amount if the issuer achieves or exceeds the agreed environmental and/or social objectives, described as the ‘sustainability performance targets’ (SPTs), or it may increase if the issuer fails to achieve these. Because of these features, SDG-linked bonds can be described as ‘forward-looking, performance-based’ financial instruments. The International Capital Markets Association (ICMA) has published ‘Sustainability-Linked Bond Principles’, which are voluntary process guidelines

Green and sustainable bonds

aiming to promote consistency, integrity and transparency for issuers, investors and others. They have five core components: 1 KPIs chosen to measure the issuer’s sustainability performance must be relevant, material, measurable and externally verifiable. 2 Sustainability performance targets (SPTs) must represent a material improvement in the chosen KPIs and should be comparable to a suitable external benchmark. 3 Bond characteristics, including the KPIs, SPTs and methodology for variation of the coupon or other aspects of the bond, should be set out in the bond documentation. 4 Reporting on KPI and SPT performance should be published at least annually. 5 Issuers should seek independent, external verification of KPI and SPT performance, and this should be made publicly available.67 A good example of a sustainability-linked bond is global fast fashion retailer H&M’s €500 million sustainability-linked bond (March 2021). This eight-and-a-half-year bond with an annual coupon of 0.25 per cent attracted strong interest from investors, and was more than seven times over-subscribed. The issue was placed by BNP Paribas, Commerzbank, Danske Bank, SEB and Standard Chartered, with SEB also acting as adviser to H&M in respect of the Sustainability-Linked Bond Principles. The KPIs and SPTs that H&M has committed to achieve, and to be verified by Sustainalytics, include: ●●

increasing its share of recycled materials used to 30 per cent;

●●

reducing emissions from H&M’s own operations by 20 per cent; and

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reducing absolute Scope 3 emissions from fabric production, garment manufacturing, raw materials and upstream transport by 10 per cent.68

Transition bonds Transition bonds are designed to support and incentivize the move by major greenhouse gas emitters to more sustainable, lower-carbon business models. Whilst a green bond is designed with use of proceeds supporting environmentally sustainable activities, transition bonds recognize that some sectors and firms (such as mining and oil and gas) cannot rapidly invest in clean infrastructure and technology and divest from carbon-intensive methods of power generation, production and distribution, but have to shift from ‘brown’ to ‘green’ over time. As we have discussed in earlier chapters, supporting the transition of sectors and firms from high- to low-carbon business models is a very important aspect of green and sustainable finance. Some, though, criticize the idea of transition bonds as potentially facilitating greenwashing by financing major emitters rather than low-carbon alternatives.

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There is as yet no recognized set of principles on agreed use of proceeds and similar criteria, similar to the Green Bond or Social Bond Principles. Given both the importance of financing organizations’ transition plans, and the potential for greenwashing by issuers keen to benefit from rising investor demand for green and sustainable bonds, in 2020 the International Capital Markets Association (ICMA) published a Climate Transition Finance Handbook to provide guidance to issuers and investors.69 The Handbook builds on and has many similarities to the Green and Social Bond Principles (examined in more detail below), the Sustainability Bond Guidelines and the Sustainability-Linked Bond Principles. Providing guidance on transition plans and the need for the alignment of these should help overcome some of the criticisms of transition bonds on greenwashing grounds. There are four key elements to the ICMA’s guidance: 1 Issuers should disclose their transition strategy, providing information on how this aligns with the objectives of the Paris Agreement and broader sustainability goals, and on the governance and oversight of the strategy. 2 The use of proceeds of transition financing should be focused on the environmentally relevant parts of the issuer’s business model. 3 Issuers’ transition strategies should be science-based, independently reviewed and verified, and publicly disclosed. 4 The implementation and progress of the transition strategy should be transparently disclosed. Whilst to date only a small number of transition bonds labelled as such have been issued, with only 11 labelled transition bonds issued in 2020, this is expected to be an area of rapid growth, with sovereign and corporate transition bonds being utilized to help major emitters of greenhouse gas emissions finance the decarbonization of their business models.

QUICK QUESTION Do you think that transition bonds facilitate greenwashing, as they have been criticized for doing? Why/why not?

Green sukuk Sukuk are a Sharia-compliant form of financial certificate; they share many features with asset-backed bonds and are sometimes referred to as Sharia-compliant bonds. Although sukuk were developed to enable financial markets to operate in a way that

Green and sustainable bonds

is appropriate to Islamic culture and laws, they also have some characteristics that proponents argue make them a natural fit for green finance and other sustainable investment portfolios. The Islamic faith and tradition – and Islamic finance – emphasize the importance of environmental stewardship, public benefit and the prevention of harm to people and planet. Like a green bond, a green sukuk is a security where the proceeds are used to support projects with environmentally focused outcomes, often infrastructure projects designed to mitigate against the effects of climate change or aid adaptation to climate change. The green sukuk market has developed more slowly than the green bond market and is still in its infancy. The world’s first green sukuk (RM250 million) was issued in July 2017 by a Malaysian renewable energy firm, with the proceeds supporting the construction of large solar energy plants. A second green sukuk (RM1 billion) was issued in October 2018 by another renewable energy firm to finance the construction of Southeast Asia’s largest solar photovoltaic plant. In March 2018, Indonesia issued the first sovereign green sukuk, raising $1.25 billion, and in 2020 it issued three further sovereign sukuk with a total value of $2.5 billion, supported by the Ministry of Finance’s Green Bond and Green Sukuk Framework,70 which established project eligibility. According to Refinitiv, total global green sukuk issuance in 2021 was $6.1 billion, a small fraction of the $523 billion of green bond issue the same year. The green sukuk market is expected to grow, however, as major Islamic financial centres and institutions promote their use.71

QUICK QUESTION In your view, are the increasing sub-categories of green and sustainable bonds beneficial or detrimental to the growth of the market?

Green and sustainable bond listings, indices and funds Stock exchange listings Stock exchanges have played a key role in developing the green bond market since the first listing of a green bond on the Luxembourg Stock Exchange in 2007. As of 2021, more than 20 stock exchanges have launched dedicated green and/or sustainable bond listings, according to the Climate Bonds Initiative.72 This includes major exchanges such as Euronext, and the Hong Kong, London, Shanghai and Singapore Stock Exchanges, as well as specialist exchanges such as the Luxembourg Green

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Exchange established in 2016. To achieve a listing, issuers need to meet the relevant exchange’s criteria for green and sustainable bonds, which in most cases are aligned to the Green Bond Principles and other international principles and frameworks as described above, and/or similar national frameworks and guidance, especially concerning use of proceeds. Stock exchanges and green/sustainable bond listings have several benefits to issuers and investors, including: ●●

●●

●●

●●

they improve the visibility and transparency of green and sustainable bonds to investors; they encourage secondary market trading and enhance liquidity for issuers, reducing risk for many investors; they increase the investor base for green and sustainable bonds, providing issuers with access to a wider pool of capital; they support the adoption of international standards, frameworks and guidance for green and sustainable bonds.

CASE STUDY Euronext ESG Bond Platform73 In November 2019, Euronext announced the creation of a new Euronext Green Bonds platform, now known as the Euronext ESG Bond Platform. It was accessible across its six market locations: Amsterdam, Brussels, Dublin, Lisbon, Oslo and Paris. At the time of launch, Euronext listed more than 250 green bonds from over 110 issuers that included sovereigns, supranational issuers, government-backed and local government entities, financial institutions, corporates and others. Sixty issuers agreed to meet or met the conditions for inclusion in the new platform. In order to be listed on the Green Bonds platform, bonds must be aligned with recognizable industry standards such as the Green Bond Principles or Climate Bonds Standard, and should have an appropriate external review performed by either an Approved Verifier under the Climate Bonds Standards or an independent third party. Building on the success of the Green Bonds platform, which saw the number of issuers increase by almost 70 per cent in the six months after its launch, in June 2020 Euronext decided to expand the platform to list a wider range of blue, social, sustainability and sustainability-linked bonds. As of March 2022, the Euronext ESG Bonds platform lists more than 900 ESG bonds from 350 issuers.

Green and sustainable bonds

Euronext describes the benefits of the ESG Bond Platform as follows: ●● ●●

●● ●●

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helping issuers increase visibility and showcase their ESG credentials; creating an engaged community of leading issuers involved in sustainable investments; helping investors access labelled ESG investments; providing a transparent discovery process ensuring investors can source ESG documentation directly from issuers; delivering an application process focused on integrity and efficiency.

As can be seen from the above case study, listings of green bonds have now evolved into a wider range of sustainability bond listings. The London Stock Exchange’s (LSE) Sustainable Bond Market, for example, now includes listings (‘segments’) for Green, Social, Sustainability, Sustainability-Linked and Green Revenue Bonds. In 2021, the LSE launched a dedicated Transition Bond Segment, which includes bonds from issuers with a corporate strategy or transition framework that is aligned with the Paris Agreement and discloses, manages and addresses climate-related risks in line with global standards such as the Climate Transition Finance Handbook, the CBI Transition Certification Framework or the Transition Pathway Initiative.74

QUICK QUESTION Research a stock exchange you are familiar with – does it have a listing for green and sustainable bonds? What are the criteria for inclusion?

Green and sustainable bond indices A stock exchange listing of green and sustainable bonds brings together all the bonds that meet an exchange’s criteria for inclusion. Whilst in the early stages of the development of the green bond market such lists were small, and issues were often similar (and therefore easily comparable), the rapid growth seen in the green and sustainable bond market means that listings can be lengthy, as in the Euronext case study above, or as in the case of the Luxembourg Green Exchange (LGX), which lists more than 1,000 bonds75 and encompasses a wide range of different green and sustainable bond types. It can therefore be difficult for investors – and potential investors – to compare and contrast bond performance. For this reason, green and sustainable bond indices have been developed.

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As we will also explore in Chapter 9, an index collects together a basket of similar assets or securities, in this case green and sustainable bonds having similar characteristics, and provides a benchmark against which investors can compare the performance of the green bonds they hold with a reference portfolio. Indices can be developed by a range of providers, most often financial data providers with the four major global index providers: S&P Dow Jones, MSCI, FTSE Russell and Bloomberg. The first green bond index was launched by Solactive in 2014,76 and in the same year the S&P Green Bond Index was launched.77 Since then, there has been considerable growth both in the number of indices and their diversity. The sustainable bond indices developed by exchanges, financial institutions and data providers now include green, social and sustainability bond indices, as well as combinations of these. An Table 7.2  Overview of green, social and sustainability bond indices Index

Investment grade

Sustainability criteria

Bond types

Coupon

Solactive Mixed Green Bond (non-investment grade and unrated included)

Corporate, financial, multilateral development bank

Fixed only

Complies with the Climate Bonds Taxonomy

S&P Dow Mixed Jones (non-investment Green Bond grade and unrated included)

Corporate, financial, government and multilateral development bank

Fixed and floating

Complies with the Climate Bonds Taxonomy

Bloomberg Investment Barclays grade only MSCI Global Green Bond

Corporate, financial, governmentrelated, treasury and securitized bonds

Fixed only

Assessed against 6 MSCI-defined environmental categories

Bank of Investment America grade only Merrill Lynch Green Bond

Includes debt of Fixed and corporate and fixed to quasi-government floating issuers, but excludes securitized and collateralized securities

Bonds must have a clearly designated use of proceeds that is solely applied toward projects or activities that promote climate change mitigation or adaptation or other environmental sustainability purposes

SOURCE  ICMA (2017) The GBP Databases and Indices Working Group – Summary of Green Fixed Income Indices Providers, https://www.cbd.int/financial/greenbonds/icma-indices2017.pdf

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overview of some of the major green and sustainable bond indices, and some of their inclusion criteria, is set out in Table 7.2. Green and sustainable bond indices offer a number of advantages to investors and others, which helps explain their increasing number and diversity. These include: ●●

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As the great majority of global assets under management are passive investments that track indices, green bond indices are an important mechanism for ensuring that investments in green and sustainable bonds are accessible to mainstream, passive funds. Developing a financial performance history for green and sustainable bonds as an asset class enables investors (and potential investors) to compare bonds’ performance against one or more benchmarks. They make possible the development of a range of green and sustainable bond index funds (discussed in the next section), facilitating investment in this asset class and widening the pool of investment capital available to issuers.

QUICK QUESTION What might be the drawbacks of the growth of a wide range of green and sustainable bond indices?

As can be seen from the simple comparison of some of the main green and sustainable bond indices in Table 7.2, one disadvantage of the growth of such indices is a lack of consistency in the qualifying criteria for use of proceeds. Even in just these four indices, three differing sets of criteria are used, and this becomes a greater issue across the growing universe of green and sustainable bond indices. This makes choosing an index as a benchmark for performance, or as the basis for a green bond index fund, more difficult – and comparability more challenging. It could also lead to accusations of greenwashing in the case of indices with less restrictive criteria.

Green and sustainable bond funds The development of green and sustainable bond listings and indices has facilitated the launch of a range of funds to make it easier for investors to access this area of the fixed income market, including index funds and exchange traded funds (ETFs). A green and sustainable bond fund invests in the universe of such bonds, or in a restricted selection in accordance with the mandate of the fund manager. Fund managers collect a fee for their role in selecting and managing a portfolio of bonds.

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There are a wide variety of such funds that cater for the differing risk appetites and other preferences of investors; examples include: ●●

NN Investment Partners Sovereign Green Bond Fund

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Franklin Municipal Green Bond Fund

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Evli Green Corporate Green Bond Fund

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PIMCO Climate Bond Fund

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BNY Mellon Sustainable Bond Fund

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Amundi Funds Emerging Markets Green Bond Fund

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Ping An China Green Bond Fund

There are a growing range of green bond funds, with more than 30 listed by Environmental Finance/Nordea in 2021, with total assets of approximately $16 billion78 (there are other funds available, too, not listed here). Funds are usually structured as listed, closed-ended investment funds with portfolios comprising a wide range of green bond issuers, sizes, currencies, sectors and geographies (referred to as ‘aggregated funds’). Some specialist green bond funds are emerging, including funds that specialize in emerging markets and sovereign green bonds. An interesting development in this area is the launch in 2019 of green bond funds for central banks by the Bank for International Settlements (BIS). The primary aim of the funds is to help central banks ‘green’ their reserves through environmentally sustainable investments.79 The launch of the fund should also stimulate increased interest by issuers in green bonds, by increasing demand and liquidity. Eligible bonds must comply with the Green Bond Principles and/or the Climate Bond Standard. In 2022, the BIS launched an Asian Green Bond Fund to help direct central bank funding to support climate change mitigation and adaptation projects and activities in the region.80 An index fund holds assets or securities that are representative of a particular index (for example, the iShares Green Bond Index Fund is predominantly comprised of the components of the Bloomberg Barclays MSCI Green Bond Index) and should deliver a return over time that is similar to that of the index overall. As we saw in the previous section, there are a wide and growing range of green and sustainable bond indices, but still a small range of index funds (there are a wider range of ETFs, described below). In addition to the iShares fund noted above, examples include: ●●

●●

Credit Suisse Green Bond Global Blue Index Fund – tracks the Bloomberg Barclays MSCI Global Green Bond Index. State Street Euro Sustainable Corporate Bond Index Fund – tracks the Markit iBoxx Euro Sustainable Corporate Bond Custom Index.

Green and sustainable bonds

As we will discuss in more detail in Chapter 9, exchange traded funds (ETFs) act in a manner similar to index funds, but have several advantages for investors and fund managers that account for their relative popularity. In the case of a green and sustainable bond ETF, the fund aims to provide investors with a return that matches the return on a specified green bond index. Rather than buying the components of the index, however, the ETF aims to match the performance of the index by investing in a wider range of financial products that may include underlying assets, as well as futures and derivatives. Shares in ETFs are listed on a stock exchange and can be bought and sold at any time. Examples of green bond ETFs include: ●●

●●

●●

Franklin Liberty Euro Green Bond ETF – aims to track the performance of the Bloomberg Barclays MSCI Euro Green Bond Index. L&G ESG Green Bond ETF – aims to track the performance of the JP Morgan ESG Green Bond Focus Index. VanEck Vectors Green Bond ETF – aims to track the S&P Green Bond Select Index.

The main advantages of index funds and ETFs to investors is that they help them more easily diversify portfolios, gain exposure to particular sectors (in this case, the sustainable fixed income market), trade securities and reduce credit and default risk. Fund managers benefit by using the methodology and analysis of the index provider to select appropriate green and sustainable bonds, reducing their investment analysis costs. Issuers benefit from the participation of a wider range of investors, widening the pool of available capital.

CASE STUDY BlackRock Launches Green Bond Index Fund81 In response to growing demand from investors, the world’s largest asset manager, BlackRock, has launched a Green Bond Index fund for those seeking exposure to environmentally positive investments. The iShares Green Bond Index Fund offers investors exposure to fixed-income securities issued to fund projects with direct environmental benefits. The fund is based on and will reflect the returns of a green bond index backed by some of the biggest names in finance: the Bloomberg Barclays MSCI Global Green Bond Index. It will include bonds issued by a wide range of governments, supranational institutions and private companies. The index offers investors an

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objective and robust measure of the global market for fixed-income securities issued to fund projects with direct environmental benefits. An independent research-driven methodology is used to evaluate index-eligible green bonds to ensure they adhere to established Green Bond Principles and to classify bonds by their environmental use of proceeds. Overview of rules for inclusion: green bond eligibility and classification ●●

●●

Green bonds are fixed-income securities in which the proceeds are exclusively and formally applied to projects or activities that promote climate or other environmental sustainability purposes. For the Bloomberg Barclays MSCI Global Green Bond Index, securities are independently evaluated by MSCI ESG Research in four dimensions to determine whether they should be classified as a green bond. These eligibility criteria reflect themes articulated in the Green Bond Principles and require commitments about a bond’s: ❍❍ ❍❍ ❍❍ ❍❍

●●

●●

stated use of proceeds process for green project evaluation and selection process for management of proceeds commitment to ongoing reporting of the environmental performance of the use of proceeds

Both self-labelled green bonds and unlabelled bonds are evaluated using these criteria for potential index inclusion. So long as projects fall within an eligible MSCI ESG Research green bond category and there is sufficient transparency on the use of proceeds, a bond will be considered for the index even if it is not explicitly marketed as green. Meeting all four criteria is required for bonds issued after the publication of the Green Bond Principles in 2014. Green bonds issued prior to 2014 that are widely accepted by investors as green bonds may still qualify for the index even if all four principles are not satisfied, since no formal guidelines were available to issuers at the time of issuance.

Green bond funds have proved successful and popular to date. Challenges to further growth are significant, however. Some green bond funds are struggling to find assets in which to invest. The dynamics of modern financial markets mean that demand from investors wanting to buy the product (in this case, shares in a green bond fund) often outstrips the supply of suitable assets in the shape of eligible and credible green bonds. Green bonds themselves are a relatively new product for which – as we

Green and sustainable bonds

have explored in this chapter – the definitions and sub-categories remain somewhat unclear. As frameworks and standards such as the Green Bond Principles, Climate Bonds Standard and forthcoming EU Green Bond Standard bring greater consistency to the market and help promote market integrity and avoid greenwashing, this barrier may be overcome

Securitization Asset-backed securities (ABS) are a type of fixed-income product similar to bonds. An issuer (often, but not always, a financial institution) makes (or buys) a range of loans that will finance green and sustainable projects or activities, bundles together (‘securitizes’) the revenues from those loans, and issues securities backed by that revenue. Bundling together revenues from such loans to create larger securities allows them to be traded with investors. The individual loans are usually relatively small, illiquid and cannot be individually traded. Securitization diversifies the risk of investing in the underlying loans, provided that the pool of loans is itself sufficiently diversified and not highly correlated.

QUICK QUESTION What might be the advantages of securitization for developing green and sustainable finance in emerging markets?

The main advantage of securitization for green and sustainable finance is that it supports the development of smaller organizations for whom the cost and complexity of issuing a green bond or similar instrument would be a significant barrier to growth. This is why green bond issuers tend to be sovereigns, municipalities, financial institutions or large, often publicly listed corporations. A ‘benchmark’ bond is usually classed as one with a face value of $500 million or a similar amount. A large corporate issuer may easily identify eligible use of proceeds for such an amount, but a smaller organization may only require a fraction of this. For this reason, securitization and the issue of asset-backed securities can be particularly important in supporting the development of green and sustainable finance in emerging markets, and scaling up medium-sized companies offering low-carbon technologies and solutions. Securitization requires a robust framework and well-developed local capital markets with the capacity, capability and regulatory oversight to support the bundling, marketing and issue of the securities.

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CASE STUDY BBOXX – securitization of off-grid solar in Africa82 BBOXX is a British-based solar energy provider established in 2010 to provide sustainable, environmentally responsible solutions to communities and businesses throughout Africa. With over 1 billion people across the world living without access to electricity, many rely on expensive and unsafe methods of lighting such as candles, diesel generators and kerosene lamps. Kerosene lamps are highly dangerous; they emit toxic fumes and have a reputation for causing accidental fires resulting in severe burns and even deaths. BBOXX designs, manufactures, finances and distributes innovative off-grid solar home kits for developing countries. The kits have replaced the use of kerosene, candles and batteries, reducing costs, health issues and carbon emissions. Most customers pay for the equipment via a three-year hire purchase agreement, paid in monthly instalments. In 2015, Oikocredit (a Dutch impact and social investor) and BBOXX partnered to create the first securitization deal for off-grid solar in Africa, raising a total of $15 million. Some of the proceeds raised were used to fund a special purpose vehicle (SPV) called Distributed Energy Asset Receivables (DEARs). This bundles the contracts of BBOXX customers in Kenya and Rwanda who have bought solar home kits. DEARs issues commercial paper, based on the value of future receivables (the monthly instalment payments) and sells this to Oikocredit. This scheme provided BBOXX with capital to supply approximately 1,200 new solar home kits to households with limited or no access to grid electricity, benefitting an estimated 7,000 people. In addition, the funding allows BBOXX to employ individuals in Kenya and Rwanda to sell, install and maintain the systems.

Securitization of mortgages is common in many jurisdictions and may be used to grow the green mortgage market. Fannie Mae, the US Federal National Mortgage Association, has issued green mortgage-backed securities since 2012, becoming one of the largest issuers of green bonds overall. In 2018, National Australia Bank issued the world’s first private Residential Mortgage-Backed Securitization, including a certified green tranche of AU $300 million that meets the criteria for low-carbon residential buildings. Some environmental NGOs, including Positive Money, have criticized the use of securitization in green and sustainable finance because it can enable the continued financing of high-carbon assets and projects, and does not necessarily result in the release of capital for new green lending and investment.83 In the case where the underlying pool of loans is considered environmentally sustainable, the proceeds

Green and sustainable bonds

from securitization do not have to be used for environmentally sustainable purposes. Alternatively, where proceeds are earmarked for environmentally sustainable purposes, the underlying loans may include loans used to finance high-emission assets or projects. For securitization to be genuinely sustainable and to avoid greenwashing, both the pool of loans and the use of proceeds must be monitored to ensure both are aligned with the relevant environmental and social sustainability criteria.

Key concepts In this chapter, we considered: ●●

●● ●●

●●

the role of the debt capital (‘fixed income’) markets, and the increasing range of green and sustainable bonds available to investors; the main types and features of green and sustainable bonds, including green sukuk; the Green Bond, Social Bond and Sustainability-Linked Bond Principles, and the Sustainability Bond Guidelines, and how these and other frameworks, standards and guidelines support the development of the green and sustainable bond market; and how securitization may be used to support smaller green and sustainable finance projects, helping these grow and develop.

Now go back through this chapter and make sure you fully understand each point.

Review Debt capital (‘fixed income’) markets play a vital role in allocating capital to finance solutions for environmental, climate change and transition challenges. Bonds are the largest single asset class in the financial system, with total issuance outstanding approximately $130 trillion. Their importance as a means of finance has increased as bank lending has tightened and equity markets are raising less new capital. Bonds are often appropriate for financing climate change mitigation and adaptation projects and activities, especially those involving renewable energy, because the majority of project costs are usually incurred upfront, during construction, whereas ongoing operating costs are low. This contrasts with traditional power generation projects, where operating costs are often higher than construction costs due to the costs of ongoing fossil fuel inputs. This transition from opex-based systems to capexbased ones is a fundamental change in how we need to think about economics and finance in the context of sustainable finance. Green bonds are those where the proceeds raised are allocated to environmental projects or uses, including but not limited to renewable energy projects, transport

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infrastructure, sustainable buildings, flood defences and sustainable forestry and agriculture. Sub-categories of green bonds include blue bonds and climate bonds. The Green Bond Principles and Climate Bonds Standard are voluntary process guidelines that aim to bring consistency, integrity and transparency to the green bond market and have helped support its growth and development. Many national and organizational green and sustainable bond frameworks reference these, as well as other ICMA Principles and Guidelines. Sustainability bonds are similar to green bonds except that proceeds may be used for a wider range of social purposes, often linked to the UN SDGs. Sustainabilitylinked and SDG-linked bonds include covenants that link a bond’s coupon to the issuer’s achievement of, or progress towards, agreed sustainability objectives, with the aim of incentivizing these. The Sustainable Bond Guidelines, Sustainability-Linked Bond Principles and SDG Impact Standards for Bonds are voluntary process guidelines for issuers of these types of bonds. Social bonds are structured in a manner similar to green bonds, except that proceeds are used to fund projects delivering positive social benefits. The Social Bond Principles are voluntary process guidelines for issuers of social bonds. Transition bonds are designed to incentivize major greenhouse gas emitters to move to more sustainable, lower-carbon business models. There is, as yet, no recognized set of principles or guidance setting out agreed use of proceeds or similar criteria. The ICMA has published a Climate Transition Finance Handbook to provide guidance to issuers and investors. Green sukuk are Sharia-compliant financial instruments, similar to green bonds. In recent years, the green and sustainable bond market has developed rapidly, with 10 consecutive years of growth and record issuance of $520 billion of green bonds, and $650 billion of sustainable and social bonds in 2021. The diversity of issuers, investors and types of green bonds has grown, and the size of issues and longer bond maturities (lengths) have also increased as the green bond market has matured. A notable development in recent years has been the growth in new sovereign issuers. Nevertheless, total issuance of green and sustainable bond types accounts for less than 5 per cent of total global bond issuance outstanding. The benefits of green bonds include: ●●

●●

●●

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they offer access to a more diversified investor base, including institutions and funds with environmental sustainability mandates, thereby helping issuers raise capital; they provide reputational benefits to the issuer, demonstrating their commitment to environmental sustainability; demand for green bonds tends to be higher than for traditional ‘vanilla’ alternatives, with green bonds oversubscribed compared with their vanilla equivalents; there is emerging evidence of a ‘greenium’ – i.e. a premium for a green bond compared with its ‘vanilla’ equivalents.

Green and sustainable bonds

Potential drawbacks of green bonds include: ●●

●●

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they are not necessarily additive, but finance projects and activities by governments and organizations that would happen anyway; they do not support organizations’ transition to low-carbon business models, although this may be overcome with transition bonds (however, these have been criticized for facilitating greenwashing); the extra costs of issuing green bonds could disincentivize investment in environmentally sustainable projects and activities (or lead issuers to use a ‘vanilla’ bond for the same purpose); the voluntary nature of many standards and frameworks for green bonds means there is a significant risk of greenwashing.

As the green and sustainable bond market has developed, related products and services have appeared, including green and sustainable bond stock market listings, indices, green bond funds, index funds and ETFs. Their growth has improved the visibility of green and sustainable bonds to investors, encourages secondary market trading, and develops a wider investment base and deeper pool of capital for issuers. Asset-backed securities are a type of debt product where an issuer (often, but not always, a financial institution) makes (or buys) a range of loans that finance green and sustainable projects or enterprises, bundles together the revenues from those loans, and issues securities that are backed by that income. Securitization, although not limited to the green and sustainable finance sector, can help smaller projects and borrowers, especially in emerging markets, access capital from large institutional investors that might otherwise not be available. Table 7.3  Key terms Term

Definition

Asset-backed securities

A type of debt product where an issuer bundles together a range of loans, securitizes the revenues from those loans, and issues securities backed by that income.

Blue bond

A sub-category of green bonds designed to support sustainable marine and fisheries projects.

Climate bond

A sub-category of green bonds where the proceeds are used to finance projects for climate change mitigation or adaptation.

Climate Bonds Standard

Developed by the Climate Bonds Initiative to provide a range of sector-specific definitions for the ‘green’ use of bond proceeds. Issuers may seek certification against the Climate Bonds Standard to reassure investors of a bond’s green credentials.

Green Bond Index

Collects together a basket of similar green and sustainable bonds, and provides a benchmark against which investors can compare the performance of the bonds they hold with this reference portfolio. (continued)

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Table 7.3  (Continued) Term

Definition

Green Bond Principles

Published by the International Capital Markets Association, the GBPs are voluntary process guidelines for green bond issuance; they recommend transparency and disclosure, and seek to promote integrity in and the development of the green bond market.

Green bond

Bonds where the proceeds raised are allocated to environmental uses or projects.

Green sukuk

A sharia-compliant bond where the proceeds are used to support projects with environmentally beneficial outcomes.

Greenium

A premium for a green bond compared with its traditional ‘vanilla’ equivalent.

Project bond

Bonds backed by a green project’s or projects’ assets and balance sheet(s) only, rather than by an issuer’s whole balance sheet.

SDG bond

A bond where proceeds are used to support the achievement of one or more of the UN Sustainable Development Goals.

SDG Impact Standards

Published by the United Nations Development Programme (UNDP), these standards seek to provide greater credibility and rigour to the issue of SDG bonds, and fit with existing principles, frameworks and tools whilst addressing gaps in current market practice.

SDG-linked bond

An SDG bond that includes a covenant linking the bond’s coupon (and occasionally other features) to the issuer’s achievement of, or progress towards, one or more of the UN Sustainable Development Goals.

Securitization

Bundling together revenues from loans to create larger, tradeable securities.

Social bond

Use of proceeds bonds that raise finance to support organizations, projects and activities with positive social outcomes.

Social Bond Principles

Published by the International Capital Markets Association, the SBPs are voluntary process guidelines that recommend transparency and disclosure, and seek to promote integrity in and the development of the social bond market.

Sustainability bond

A bond where proceeds are used to finance a combination of both green and social projects, often linked to the UN’s Sustainable Development Goals (SDGs). They therefore combine the use of proceeds of green and social bonds.

Sustainability Bond Guidelines

Published by the International Capital Markets Association, the SBGs are voluntary process guidelines that aim to promote consistency, integrity and transparency in this category of bonds.

Sustainabilitylinked bond

A sustainability bond that includes a covenant linking the bond’s coupon (and occasionally other features) to the issuer’s achievement of, or progress towards, agreed sustainability objectives. (continued)

Green and sustainable bonds

Table 7.3  (Continued) Term

Definition

SustainabilityLinked Bond Principles

Published by the International Capital Markets Association, the SLBPs are voluntary process guidelines that seek to incentivize issuers to achieve material sustainability (ESG) objectives, and that recommend bond structuring features, disclosure, reporting and verification to ensure this.

Transition bond

Transition bonds are designed to incentivize major greenhouse gas emitters to move to more sustainable, lower-carbon business models. There is no recognized set of principles or guidance setting out agreed use of proceeds and similar criteria; however, the International Capital Markets Association has published a Climate Transition Finance Handbook to provide guidance to issuers and investors.

Use of proceeds bond

Organization-guaranteed bonds used to raise money for general purposes and that are backed by the issuing organization as a whole. Use of the money raised (proceeds) may be linked to certain qualifying assets or purposes – in the case of green use of proceeds bonds, for activities delivering environmental sustainability benefits.

Notes 1 ICMA (2020) Secondary markets: Bond market size, https://www.icmagroup.org/marketpractice-and-regulatory-policy/secondary-markets/bond-market-size/ (archived at https:// perma.cc/2UMG-JNH4) 2 IEA (2019) Financing and funding trends, https://www.iea.org/reports/world-energyinvestment-2019/financing-and-funding-trends (archived at https://perma.cc/HYH3-FJVB) 3 Jones, L (2022) $500bn Green Issuance 2021: Social and sustainable acceleration: annual green $1tn in sight: market expansion forecasts for 2022 and 2025, https://www. climatebonds.net/2022/01/500bn-green-issuance-2021-social-and-sustainable-accelerationannual-green-1tn-sight-market (archived at https://perma.cc/5WL5-JLJY) 4 BNP Paribas (2022) Research and Documentation, https://invest.bnpparibas.com/sites/ default/files/documents/201012_-_bnpp_green_nps_-_final_terms_signed.pdf (archived at https://perma.cc/4NUX-UCHX) 5 European Investment Bank (2022) Climate Awareness Bonds, https://www.eib.org/en/ investor_relations/cab/index.htm (archived at https://perma.cc/HX33-2YX4) 6 World Bank Group (2019) 10 Years of Green Bonds: Creating the blueprint for sustainability across capital markets, https://www.worldbank.org/en/news/ immersive-story/2019/03/18/10-years-of-green-bonds-creating-the-blueprint-forsustainability-across-capital-markets (archived at https://perma.cc/UC8C-MP22)

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Green and Sustainable Finance 7 Harrison C, MacGeoch, M and Michetti, C (2021) Sustainable Debt Global State of the Market 2021, https://www.climatebonds.net/files/reports/cbi_global_sotm_2021_02h_0. pdf (archived at https://perma.cc/MN92-2QM5) 8 Ibid 9 Ibid 10 HM Treasury (2021) UK’s first Green Gilt raises £10 billion for green project, https:// www.gov.uk/government/news/uks-first-green-gilt-raises-10-billion-for-green-projects (archived at https://perma.cc/8PTZ-XQGE) 11 Fatin, L (2021) COP26 Briefing: Sovereign Green Bond issuance takes off! Start of a long boom, https://www.climatebonds.net/2021/11/cop26-briefing-sovereign-green-bondissuance-takes-start-long-boom (archived at https://perma.cc/2VX4-F4RN) 12 Harrison C, MacGeoch, M and Michetti C (2021) Sustainable Debt Global State of the Market 2021, https://www.climatebonds.net/files/reports/cbi_global_sotm_2021_02h_0. pdf (archived at https://perma.cc/MN92-2QM5) 13 Department of Treasury and Finance Victoria (2016) Green Bonds, https://www.dtf. vic.gov.au/funds-programs-and-policies/green-bonds (archived at https://perma.cc/ M54G-DCYZ) 14 Climate Bonds Initiative (nd) National Australia Bank, Climate Bonds, https://www. climatebonds.net/certification/national-australia-bank (archived at https://perma.cc/ RB6L-LJ2D) 15 Westpac IQ (nd) Home, https://westpaciq.westpac.com.au/Article/46618 (archived at https://perma.cc/GZR4-YTZK) 16 BNDES (2021) BNDES creates new structure for issuing green, social and sustainable bonds, with support from IDB, https://www.bndes.gov.br/SiteBNDES/bndes/bndes_en/ conteudos/noticia/BNDES-creates-new-structure-for-issuing-green-social-and-sustainablebonds-with-support-from-IDB/ (archived at https://perma.cc/TWG4-PUT3) 17 Climate Bonds Initiative (2022) Latin America & Caribbean State of the Market 2021, https://www.climatebonds.net/files/reports/cbi_lac_2020_04e.pdf (archived at https:// perma.cc/6NLS-J8SW) 18 Republic of Chile (2019) Green Bond Framework, https://www.climatebonds.net/files/files/ Chilepercent20Sovereignpercent20Greenpercent20Bondpercent20Framework.pdf 19 LSEG (2019) Fixed Income Pulse: Chile becomes the first sovereign from Americas to issue green bonds, https://www.londonstockexchange.com/discover/news-and-insights/ fixed-income-pulse-chile-becomes-first-sovereign-americas-issue-green-bonds (archived at https://perma.cc/RR47-C6H4) 20 Climate Bonds Initiative (2022) Latin America & Caribbean State of the Market 2021, https://www.climatebonds.net/files/reports/cbi_lac_2020_04e.pdf (archived at https:// perma.cc/5RSW-3UUZ) 21 People’s Bank of China (2021) Green Bond Endorsed Projects Catalogue, http://www. pbc.gov.cn/goutongjiaoliu/113456/113469/4342400/2021091617180089879.pdf (archived at https://perma.cc/3QVJ-DDL4)

Green and sustainable bonds 22 Climate Bonds Initiative (2021) China Green Bond Market Report 2020, https://www. climatebonds.net/files/reports/cbi_china_sotm_2021_06d.pdf (archived at https://perma. cc/WC4M-9YUU) 23 S&P Global (2022) China green bond issuances set to cross $100B mark in 2022, https:// www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/chinagreen-bond-issuances-set-to-cross-100b-mark-in-2022-68453272 (archived at https://perma.cc/3TTU-XVHD) 24 Euronext (nd) Live Markets, https://live.euronext.com/en/products/fixed-income/ esg-bonds?field_type_value=1 (archived at https://perma.cc/U5GW-LE89) 25 Climate Bonds Initiative (2022) $500bn Green Issuance 2021, https://www.climatebonds. net/2022/01/500bn-green-issuance-2021-social-and-sustainable-acceleration-annualgreen-1tn-sight-market (archived at https://perma.cc/2YZ9-2P8M) 26 Federal Ministry of Finance (2021) Green Federal Securities, https://www.deutschefinanzagentur.de/en/institutional-investors/federal-securities/green-federal-securities/ (archived at https://perma.cc/5D3G-P9EL) 27 Climate Bonds Initiative (2022) India Sustainable Debt State of the Market 2021, https:// www.climatebonds.net/files/reports/cbi_india_sotm_2021_final.pdf (archived at https:// perma.cc/8MLQ-S2E5) 28 Ministry of the Environment (2020) Green Bond guidelines, www.env.go.jp/ content/000042342.pdf (archived at https://perma.cc/GR4F-YC33) 29 Ministry of the Environment (2020) Green Bond issuance promotion platform, http:// greenbondplatform.env.go.jp/en/ 30 Climate Bonds Initiative (2021) Japan Green Finance – State of the Market 2020, https:// www.climatebonds.net/files/reports/cbi_jpn_sotm_20_02d.pdf (archived at https://perma. cc/M5ZB-7YDG) 31 CCFC (2018) Green Bond Principles MX, http://www.mexico2.com.mx/uploadsmexico/ file/GREEN_BONDS_PRIN_MX2(1)pdf 32 Climate Bonds Initiative (2022) Latin America & Caribbean State of the Market 2021, https://www.climatebonds.net/files/reports/cbi_lac_2020_04e.pdf (archived at https:// perma.cc/9T8P-JPD2) 33 Monetary Authority of Singapore (MAS) (nd) Sustainable Bond Grant Scheme, https:// www.mas.gov.sg/schemes-and-initiatives/sustainable-bond-grant-scheme (archived at https://perma.cc/VBR9-GBP7) 34 Climate Bonds Initiative (2021) ASEAN Sustainable Finance State of the Market 2020, https://www.climatebonds.net/files/reports/asean-sotm-2020.pdf (archived at https:// perma.cc/EDV3-Q89K) 35 The Straits Times (2022) Budget 2022: $35 billion in green bonds to be issued by 2030 to fund green public sector projects, https://www.straitstimes.com/singapore/ budget-2022-35-billion-in-green-bonds-to-be-issued-by-2030-to-fund-green-publicsector-projects (archived at https://perma.cc/62MC-2AGC) 36 DBSA (2021) Green Bond Framework, https://www.dbsa.org/sites/default/files/media/ documents/2021-03/DBSApercent20Greenpercent20Bondpercent20Frameworkper cent20-percent2022percent20Januarypercent202021.pdf

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Green and Sustainable Finance 37 Climate Bonds Initiative (2021) Nordic Sustainable Debt State of the Market 2020, https://www.climatebonds.net/files/reports/cbi_nordic_sotm_2020_02e.pdf (archived at https://perma.cc/U6GN-S5A4) 38 Ministry of Finance (2020) Sweden’s Sovereign Green Bond Framework, https://www. riksgalden.se/globalassets/dokument_eng/debt/borrowing/swedens-sovereign-green-bondframework.pdf (archived at https://perma.cc/JWP7-LA7A) 39 HM Treasury (2021) UK’s first Green Gilt raises £10 billion for green projects, https:// www.gov.uk/government/news/uks-first-green-gilt-raises-10-billion-for-green-projects (archived at https://perma.cc/P6LF-C2VN) 40 HM Treasury (2021) Second UK Green Gilt raises further £6 billion for green projects, https://www.gov.uk/government/news/second-uk-green-gilt-raises-further-6-billion-forgreen-projects (archived at https://perma.cc/S9VZ-XDER) 41 HM Treasury (2021) UK Government Green Financing Framework, https://assets. publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/ file/1002578/20210630_UK_Government_Green_Financing_Framework.pdf (archived at https://perma.cc/93E6-CRPZ) 42 ICMA (2021) Green Bond Principles: Voluntary process guidelines for issuing Green Bonds, https://www.icmagroup.org/assets/documents/Sustainable-finance/2021updates/Green-Bond-Principles-June-2021-140621.pdf (archived at https://perma.cc/ NC9A-48RT) 43 ICMA (2022) Green Projects: Impact Reporting, https://www.icmagroup.org/sustainablefinance/impact-reporting/ (archived at https://perma.cc/TUW2-KRYE) 44 ICMA (2021) Green Bond Principles: Voluntary process guidelines for issuing Green Bonds, https://www.icmagroup.org/assets/documents/Sustainable-finance/2021updates/Green-Bond-Principles-June-2021-140621.pdf (archived at https://perma.cc/​ 8WQ8-W359) 45 NatWest Group (2022) Green, Social and Sustainability Bonds, https://investors.­ natwestgroup.com/fixed-income-investors/green-social-and-sustainability-bonds/ gss-bonds (archived at https://perma.cc/7TQ3-44GE) 46 EDF (2020) EDF Green Bond Framework, https://www.edf.fr/sites/default/files/ contrib/groupe-edf/espaces-dedies/espace-finance-fr/investisseurs-et-analystes/ espacepercent20obligataire/Green-Bond/edf_green_bond_framework_2020-01-21.pdf 47 Climate Bonds Initiative (2017) An oil & gas bond we knew would come eventually: Repsol: Good on GBPs, not so sure on green credentials, https://www.climatebonds. net/2017/05/oil-gas-bond-we-knew-would-come-eventually-repsol-good-gbps-not-sosure-green-credentials (archived at https://perma.cc/3H93-VMKW) 48 European Parliament (2022) Committee on the Environment, Public Health and Food Safety, https://www.europarl.europa.eu/doceo/document/ENVI-AD-697683_EN.pdf (archived at https://perma.cc/J2NA-JPB4) 49 Climate Bonds Initiative (2016) China Green Bond Market 2016, https://www.­ climatebonds.net/resources/reports/china-green-bond-market-2016 (archived at https:// perma.cc/7A6V-WGWP)

Green and sustainable bonds 50 People’s Bank of China (2021) Green Bond Endorsed Projects Catalogue, http://www. pbc.gov.cn/goutongjiaoliu/113456/113469/4342400/2021091617180089879.pdf (archived at https://perma.cc/B5MG-LVZ4) 51 European Bank for Reconstruction and Development (nd) EBRD’s Green Bond Issuance, https://www.ebrd.com/work-with-us/sri/green-bond-issuance.html (archived at https:// perma.cc/A8J8-CF87) 52 European Bank for Reconstruction and Development (2022) Focus on Environment, https://www.ebrd.com/focus-on-environment.pdf (archived at https://perma.cc/ DK4J-SVQ5) 53 NatWest Group (2020) Green, Social and Sustainability Bond Framework: Building a purpose-led bank, https://investors.natwestgroup.com/~/media/Files/R/RBS-IR-V2/greensocial-and-sustainability-bonds/gss-bond-framework-oct-2020.pdf (archived at https:// perma.cc/KW2L-YQRM) 54 Climate Bonds Initiative (2020): Green Bonds Treasurer Survey (2020), https://www. climatebonds.net/resources/press-releases/2020/04/green-bond-treasurer-survey-issuersidentify-multiple-benefits (archived at https://perma.cc/Q2AG-CXCL) 55 Climate Bonds Initiative (2021) Green Bond pricing in the primary market H2 2020, https://www.climatebonds.net/resources/reports/green-bond-pricing-primarymarket-h2-2020 (archived at https://perma.cc/WEL8-WGPW) 56 The Nature Conservancy (2021) Blue Bonds: An audacious plan to save the world’s ocean, https://www.nature.org/en-us/what-we-do/our-insights/perspectives/an-audaciousplan-to-save-the-worlds-oceans/ (archived at https://perma.cc/Q4MA-26JG) 57 Asian Development Bank (2021) Green and Blue Bond Framework, https://www.adb. org/sites/default/files/publication/731026/adb-green-blue-bond-framework.pdf (archived at https://perma.cc/PR2P-WWL6) 58 Climate Bonds Initiative (2019) Climate Bonds Standard, Version 3.0, https://www. climatebonds.net/files/files/climate-bonds-standard-v3-20191210.pdf (archived at https:// perma.cc/SL2V-YUPG) 59 Climate Bonds Initiative (2022) Sector criteria available for certification, https://www. climatebonds.net/standard/available (archived at https://perma.cc/27JK-MRSG) 60 HSBC (2022) Green and Sustainability Bonds, https://www.hsbc.com/investors/ fixed-income-investors/green-and-sustainability-bonds (archived at https://perma.cc/ K4P4-87YS) 61 SDG Impact (2022) SDG Impact Standards for Bond Issuers, https://sdgimpact.undp.org/ sdg-bonds.html (archived at https://perma.cc/WQQ8-RQC8) 62 ICMA (2021) Social Bond Principles: Voluntary process guidelines for issuing social bonds, https://www.icmagroup.org/assets/documents/Sustainable-finance/2021-updates/ Social-Bond-Principles-June-2021-140621.pdf (archived at https://perma.cc/J7D3-8Q3S) 63 Jones, L (2022) $500bn Green Issuance 2021: Social and sustainable acceleration: Annual green $1tn in Sight: market expansion forecasts for 2022 and 2025, https:// www.climatebonds.net/2022/01/500bn-green-issuance-2021-social-and-­sustainableacceleration-annual-green-1tn-sight-market (archived at https://perma.cc/V7RK-HMUP)

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Green and Sustainable Finance 64 European Commission (2021–22) Sure Social Bonds, https://ec.europa.eu/info/strategy/ eu-budget/eu-borrower-investor-relations/sure-social-bonds_en (archived at https:// perma.cc/W6HN-HXFV) 65 University of Oxford Government Outcomes Lab (nd) Impact Bond Dataset, https:// golab.bsg.ox.ac.uk/knowledge-bank/indigo/impact-bond-dataset-v2/ (archived at https:// perma.cc/SXM7-QACA) 66 ICMA (2018) Sustainability Bond Guidelines, https://www.icmagroup.org/assets/­ documents/Regulatory/Green-Bonds/Sustainability-Bonds-Guidelines-June-2018-270520. pdf (archived at https://perma.cc/9LP9-QBT4) 67 ICMA (2020) Sustainability-Linked Bond Principles, https://www.icmagroup.org/assets/ documents/Regulatory/Green-Bonds/June-2020/Sustainability-Linked-Bond-PrinciplesJune-2020-171120.pdf (archived at https://perma.cc/G3ZE-N4EZ) 68 H&M Group (2021) H&M Group’s sustainability work attracts bond market attention, https://hmgroup.com/news/hm-groups-sustainability-work-attracts-bond-market-­ attention/ (archived at https://perma.cc/V3Z3-AC88) 69 ICMA (2020) Climate Transition Finance Handbook, https://www.icmagroup.org/ assets/documents/Regulatory/Green-Bonds/Climate-Transition-Finance-HandbookDecember-2020-091220.pdf (archived at https://perma.cc/4NJH-9RKF) 70 The Republic of Indonesia (nd) Green Bond and Green Sukuk Framework 71 Refinitiv (2022): Green and sustainability sukuk set new records. Available at: https:// www.refinitiv.com/perspectives/market-insights/green-and-sustainability-sukuk-set-newrecords/ (archived at https://perma.cc/A775-6Z2K) 72 Climate Bonds Initiative (2022) Green Bond Segments on Stock Exchanges, https://www. climatebonds.net/green-bond-segments-stock-exchanges (archived at https://perma.cc/​ 5CWH-ZHMQ) 73 Euronext (2022) Listing Bonds, https://www.euronext.com/en/list-products/bonds/ esg-bonds (archived at https://perma.cc/V9R8-JVMM); Euronext (2022) Green Bonds offering: A new Euronext Initiative, https://www.euronext.com/en/news/green-bondsoffering-new-euronext-initiative (archived at https://perma.cc/434U-7E3R) 74 London Stock Exchange (2022) Transition Bond Segment, https://www.­ londonstockexchange.com/raise-finance/debt/our-products/sustainable-bond-market/ transition-bond-segment (archived at https://perma.cc/DL3A-43VQ) 75 Luxembourg Stock Exchange (2022) Luxembourg Green Exchange, https://www.bourse. lu/green (archived at https://perma.cc/44CY-7WLB) 76 Solactive (2022) Solactive Green Bond Index, https://www.solactive.com/?allgemein/ lithium-reporting/?lang=DE000A1EY8J4&index=DE000SLA0FS4 (archived at https:// perma.cc/Y6BY-YTAC) 77 S&P Dow Jones Indices (2022) S&P Green Bond Index, https://www.spglobal.com/spdji/ en/indices/esg/sp-green-bond-index/#overview (archived at https://perma.cc/2DMX-F8EK) 78 Environmental Finance (2021) Actively Managed Green Bond Funds Table, https://www. environmental-finance.com/content/analysis/actively-managed-green-bond-funds-table. html (archived at https://perma.cc/8KC9-AA8D)

Green and sustainable bonds 79 BIS (2019) BIS Launches Green Bond Fund for Central Banks, https://www.bis.org/press/ p190926.htm (archived at https://perma.cc/7KBF-ESTR) 80 BIS (2022) BIS Launches Asian Green Bond Fund, https://www.bis.org/press/p220225. htm (archived at https://perma.cc/2KZF-Y7YT) 81 MSCI (2019) Barclays MSCI Green Bond Indices: Bringing clarity to the green bond market through benchmark indices, https://www.cib.barclays/content/dam/ barclaysmicrosites/ibpublic/documents/investment-bank/global-insights/green-bondbenchmark-indices-bringing-clarity-to-the-green-bond-market-696kb.pdf (archived at https://perma.cc/LB9T-R6FD) 82 BBOXX, Oikocredit and ESI Africa (2016) Adapted by author 83 Barnes, D (nd) Securitization is back, and green finance must stray far away, Positive Money, https://www.positivemoney.org/2019/09/securitization-is-back-andgreen-fin​ance-must-stray-far-away/

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­ entral and development C banks Introduction In Chapter  6, we distinguished between four types of banks: retail banks, wholesale and investment banks, central banks and development banks, the last two being public rather than private institutions. Central banks play key roles in ensuring financial stability and shaping the financial services regulatory landscape; in Chapter 5 we examined how central banks and financial regulators are increasingly coordinating regulatory approaches to climate risk. In this chapter, we focus on how central banks can address climate, environmental and sustainability risks and promote the growth of green and sustainable finance through their monetary policy and other banking operations. Development banks – including international financial institutions such as the World Bank, as well as regional and national development banks – are major promoters of economic development. Given the very significant risks to the financial system posed by climate change and the transition to a low-carbon economy, along with the need to support sustainable economic development in many parts of the world, development banks have a keen interest in seeing green and sustainable finance contribute to the achievement of their public policy and development objectives.

L E A R N I N G OB J ECTI VES On completion of this chapter, you will be able to: ●●

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Explain the role of central banks and development banks (multilateral and national) in relation to green and sustainable finance. ­ escribe how central banks can support the transition to a low-carbon D economy through their monetary policy and other banking operations

Central and development banks

(their role as financial regulators, and in relation to identifying, measuring and disclosing climate risk, is covered in Chapter 5). ●●

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Describe how development banks play a key role in promoting sustainable economic development and unlocking private finance, and the products and services they provide in order to do this. Cite examples and case studies of central and development banks supporting green and sustainable finance.

The role of central banks Central banks (sometimes referred to as reserve banks) are institutions that oversee the financial system and monetary regime of a country. In many countries, central banks are publicly owned, but institutionally independent from the government. Examples of central banks include the US Federal Reserve, the Bank of England, the European Central Bank and the People’s Bank of China. A central bank is not a commercial bank – it is usually not possible for a member of the public to open an account at a central bank or ask for a loan. The role of central banks has varied widely throughout history, but modern central banks typically have two key roles: ●●

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Monetary policy: They issue banknotes and coins, and set monetary policy to ensure stable prices and confidence in the currency. Many countries have an inflation target, often set by the government, that the central bank should achieve. Setting base interest rates is the main action central banks take to conduct monetary policy. Financial stability: They supervise the financial system, using their supervisory and regulatory powers to ensure the solvency of financial institutions, avoid bank runs and prevent reckless or fraudulent behaviour by banks and other regulated bodies. They also act as ‘lender of last resort’ to the banking sector during times of financial crisis.

In some, but not all, countries, the central bank also acts as the financial regulator, either directly or through a subsidiary organization. In Chapter 5, we examined how financial regulators, including central banks, are increasingly coordinating approaches to regulation in order to identify, measure and disclose climate risk, and promote the growth of green and sustainable finance. In this Chapter, we focus on central banks’ other roles and responsibilities, especially in relation to monetary policy, although there is necessarily overlap between the two.

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QUICK QUESTION In what ways do you think the activities of central banks could affect the natural environment?

Central banks and climate change In some countries, central banks have wider economic objectives beyond monetary and financial stability, such as supporting full employment or promoting economic growth. Some believe that central banks’ mandates should also include tackling climate change, both in terms of climate change as a systemic, global issue in its own right, and because of the impacts of climate change on monetary policy and – in particular – financial stability. A small number of countries’ central banks – 15 out of 135 studied by Dikau and Volz (2020) have an explicit mandate to support sustainable economic growth, and a further 54 have a broader objective to support their government’s policy objectives, which may include sustainability goals.1 Central banks with an explicit sustainability mandate include those of Malaysia, Singapore, the Russian Federation and South Africa, though the majority do not represent major economies and/or emitters of greenhouse gases. The first G7 country to include sustainability in its central bank’s mandate is the UK. In March 2021, the UK Chancellor of the Exchequer (Minister of Finance) announced that the Bank of England’s mandate would be revised to reflect the importance of climate change and the transition to net zero ‘with a view to building the resilience of the UK financial system to the risks from climate change and support the government’s ambition of a greener industry, using innovation and finance to protect our environment and tackle climate change.’2

QUICK QUESTION What does the mandate of the central bank in the country where you live and work state about its responsibilities (if any) to pursue sustainability?

Monetary policy and sustainability Since the 2007/08 global financial crisis, and subsequently in response to the economic challenges of the Covid-19 pandemic, central banks have expanded their range of

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tools for supporting their monetary, financial stability and other objectives, and have played a more interventionist role in many economies. This includes the use of quantitative easing to achieve monetary policy objectives and a range of macroprudential and microprudential policies and tools to achieve financial stability objectives: ●●

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­ uantitative easing (QE): An unconventional form of monetary policy where Q a central bank creates new money electronically to buy financial assets, such as government bonds, aiming to directly increase private sector spending in the economy and return inflation to target. Macroprudential policy: Seeks to prevent an excessive build-up of systemic risk in the financial system resulting from factors such as asset price bubbles or excessive risk-taking by banks. Examples of macroprudential policies include restrictions on certain types of lending, or increased capital requirements for certain types of assets. Microprudential policy: Oversight of financial institutions that seeks to ensure their solvency and prevent financial contagion in the event of failure. This is often referred to as ‘supervision’; the role of central banks as financial regulators and supervisors in the context of climate risk and sustainable finance was discussed in Chapter 5.

With responsibility for overseeing financial stability, central banks have a particularly important impact on the way in which commercial banks and other financial institutions respond to the physical and transition risks associated with climate change. Even where environmental objectives are not part of a central bank’s explicit mandate, the incorporation of environmental sustainability factors may be relevant to ensure that material risks facing the financial system are identified, disclosed and managed, to achieve price stability and/or to safeguard financial stability. As we have seen in earlier chapters, central banks are working together in an increasingly coordinated manner in this area, through bodies such as the Bank for International Settlements (BIS), the Financial Stability Board (FSB) and the Network for Greening the Financial System (NGFS). Moreover, with responsibility for overseeing and regulating the creation and allocation of money and credit, central banks can have a particularly important impact on the speed at which the greening of the financial system takes place, by incentivizing or directing resources from traditional, carbon-intensive sectors towards green and sustainable alternatives. Conversely, through policies such as quantitative easing, central banks may be inadvertently supporting high-carbon industries, as the reading below argues.

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READING Printing money, burning carbon? Why QE may be stimulating more than just the money markets3 New research suggests corporate bond purchases by central banks may be inadvertently backing carbon-intensive sectors. Central banks may be inadvertently prolonging the life of the high-carbon economy, according to new research that suggests measures used by such bodies to stimulate growth may work in favour of market incumbents that pollute. Research published by the Grantham Research Institute on Climate Change and the Environment at the LSE, suggests that quantitative easing (QE) – where a central bank creates new money to buy assets and drive wider spending in the economy – may be supporting highcarbon sectors at the expense of greener alternatives. The paper looks specifically at a subsector of QE – the purchase of corporate bonds, introduced by the Bank of England and the European Central Bank in 2016 in a bid to prompt more lending activity in the economy. Although it still represents a relatively small sub-sector of QE programmes, the majority of which are delivered through the purchase of public assets such as gilts, the corporate bond-buying programmes of the ECB and the BoE send an important message of confidence in certain sectors to the wider financial market. According to the report, 62.1 per cent of the ECB’s corporate bond purchases under its €82 billion corporate bond purchase programme have been in the manufacturing and utilities sectors, despite the fact that they only make up 18 per cent of the Eurozone economy. These sectors produce 58.5 per cent of greenhouse gas emissions in the Eurozone. Meanwhile, under the BoE £10 billion corporate bond programme, 49.2 per cent of purchases have been made in utilities and manufacturing, where they make up 11.8 per cent of the UK economy and produce 52 per cent of the country’s greenhouse gas emissions. Neither of the central banks has purchased any bonds representing renewable energy companies, whereas oil and gas companies make up 8.4 per cent of ECB corporate bond purchases and 1.8 per cent of BoE corporate bond purchases. The findings are at odds with the public stance taken by BoE governor Mark Carney, who gave a highly influential speech in 2015 on the risks from climate change’s ‘tragedy of the horizon’ and has urged corporates to be more transparent about their assessment criteria for climate risk. ‘This strategy is in direct contradiction with, and may undermine, the signals that financial regulators are making about the risks associated with high-carbon investments and the impact on market efficiency,’ the report notes. ‘While monetary

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policy cannot be a substitute for environmental policy, monetary policymakers should be mindful of the impacts on asset pricing, including risks to market efficiency and financial stability.’ The report also points to evidence of a ‘disproportionate jump’ in the price of eligible assets after the introduction of central bank corporate bond purchasing programmes. This could ‘exacerbate existing mispricing’ around highcarbon sectors, it warns. But the QE programmes are meant to be sector neutral to avoid market distortions, and despite warning the wider financial sector of the potential impact of climate change, the central banks have to date maintained that intervening more directly to support the low-carbon transition is outside of their apolitical mandate. Therefore, their corporate bond choices are made using a strict set of criteria, explains Sini Matikainen, a policy analyst at the Grantham Research Institute and lead author of the report. ‘[Buying] corporate bonds is already restricted to certain companies that are issuing corporate bonds,’ she tells Business Green. ‘So that already restricts the sectors. Then both banks set an eligibility criterion: that they want to buy something that is investment grade, with a very high credit rating and a certain maturity. So that restricts it as well. And then they take out [the] financial sector because they don’t want to be seen as preferentially buying from the financial sector, so they get rid of the bank bonds and so on. So at every stage it takes some corporations out. To a certain extent this is a structural problem – it doesn’t appear to be a deliberate attempt by the central banks to focus on manufacturing and utilities,’ she concludes. Added to that, central banks can only purchase available issuances. If there simply aren’t green bond issuances on the market, for example, the central bank can’t buy. In response to the report, a spokesperson for the ECB insisted that it is not practically possible for the central bank to start embedding non-monetary policy considerations into its QE corporate bond programme. ‘The ECB does not favour specific sectors, it roughly “buys the market”,’ they said in a statement. ‘Given the relatively small size of the euro area corporate bond market, it is not possible to embed non-monetary policy considerations into a large-scale asset purchase programme that is carried out as [a] temporary monetary policy measure over a relatively short time period. They would limit the effectiveness of the programme. A number of assets that are classified as “green bonds” are eligible for the CSPP and have also been purchased by the Eurosystem.’ But Matikainen insists there are measures the central banks can implement without taking direct measures to favour bond purchases in low-carbon sectors. Firstly, the system currently favours incumbents – the established companies with strong investment histories and good credit ratings that easily meet the central

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banks’ criteria. The central banks could work with other institutions to lend a hand to some of the smaller market insurgents, which low-carbon firms tend to be, to help them clear criteria hurdles larger counterparts sail through. ‘We’d like to see the central banks seeing themselves as working with and in collaboration with these other institutions,’ she explains. ‘If you have a new [renewable energy] company that would like to issue corporate bonds but it can’t get the appropriate credit rating because it doesn’t have enough credit history or there is uncertainty about the future direction of renewable energy prices, it might be that instead of lowering the eligibility criteria that requires intervention from someone else.’ Matikainen continues: ‘So one thing that we mention in the paper is that the European Investment Bank (EIB) has this project bond investment enhancement tool, which is used to actually increase the credit rating of project bonds . . . So it could be that you realize there is this skew towards manufacturing and utilities which reflect[s] an overall problem in the financial sector, it could be that the real problem is coming from other areas but it requires some kind of awareness or coordination.’ Such tools could be used to enhance the credit rating of green projects, she suggested. To kick this off, the paper calls for the central banks to initiate reviews into their processes to assess climate impacts. The mere act of opening up the discussion on the problem may prompt a much wider awareness of an inherent bias in the system that institutions can collaborate to address, it suggests. Should the integration of corporate bonds into QE continue in the long term, incorporating climate risk into the eligibility criteria may be an option, particularly now ratings agencies are beginning to do the same and more climate disclosure data is starting to feed through onto the open market. ‘By mainstreaming climate considerations into their day-to-day operations and disclosing their approach to transitional risk, central banks would send a strong signal to financial markets and begin to address their own “tragedy of the horizon”,’ the report suggests. The paper makes clear that any bias towards high-carbon bond purchases is the result of a set of stringent eligibility criteria that inadvertently favour market incumbents. But the unintended consequences of such corporate bond QE programmes deserve to be investigated more fully, particularly when central banks are beginning to take more of a leadership position in the climate debate. The carbon impact of QE may seem like an obscure topic, but if we aren’t careful we may find we are using new money to prop up old, polluting industries.

Central and development banks

Some central banks are now taking – or considering – active steps to decarbonize their asset purchase programmes. For instance: ●●

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In 2018, the People’s Bank of China (central bank) included green bonds in the pool of assets eligible for its Medium-Term Lending Facility. The European Central Bank announced in 2020 that it would accept sustainability-linked bonds as eligible for its asset purchase schemes (green bonds were already eligible), and in 2021 that it would invest in the Bank for International Settlements’ Green Bond Fund. The Swedish Central Bank’s (Sveriges Riksbank) asset purchasing programme was updated in 2020 to include Swedish sovereign and municipal green bonds, plus corporate bonds where issuers comply with ‘international standards and norms for sustainability’. The Swiss National Bank has announced that it will exclude all coal extraction and power production from its bond purchases.

Reflecting the recent change to its mandate, the Bank of England announced in 2021 that it will ‘tilt’ its asset purchases, through its Corporate Bond Purchase Scheme (CBPS), to reflect the risks inherent in exposure to high-carbon firms and sectors. It will begin by excluding thermal coal from purchases, and over time extend this to other sectors incompatible with achieving net zero by 2050. As well as reducing climate risk in the Bank of England’s own portfolio, this should encourage and incentivize issuers’ transition plans, and encourage other investors to take similar action.

Using central bank tools to promote sustainability As discussed in the previous section and in Chapter 5 (in the context of central banks as financial regulators), many central banks are playing an increasingly active role in addressing the risks posed by climate change and supporting the greening of the financial system. This is the case individually, and collectively through bodies such as the Network for Greening the Financial System (NGFS). While some central banks are more advanced in this area than others, there is an increasing recalibration of traditional tools central banks use in support of their monetary policy and financial stability objectives (credit guidance policies, microprudential regulation and supervision) to incorporate environmental sustainability, in particular, and to encourage the growth of green and sustainable finance. We look at four of these tools in this section: ●●

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credit allocation instruments that aim to encourage the flow of credit to environmentally sustainable sectors; risk weightings that incentivize lending to environmentally sustainable sectors, firms and activities, and/or penalize lending to environmentally harmful sectors, firms and activities;

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microprudential regulation and firm supervision (building on our earlier discussion of regulatory approaches to climate risk in Chapter 5); developing and promoting green and sustainable finance guidelines, frameworks and initiatives.

Credit allocation instruments Credit allocation policies, also known as credit guidance policies, direct the creation and allocation of credit towards certain industries or sectors. Historically, credit allocation policies have been used by central banks to guide lending to prioritized sectors deemed essential for economic development. More recently, these policies have been used in some countries to direct credit towards green and sustainable areas, and away from environmentally harmful activities. Three main policy instruments are employed to direct credit towards environmentally sustainable activities. Firstly, targeted refinancing lines offer central bank finance to commercial banks at reduced interest rates for specified asset classes. In contrast to outright subsidies, they rely on the private sector as a gatekeeper in the allocation of capital. The default risk remains with the banking sector. Targeted refinancing lines have been a common policy tool used by many central banks in emerging and developing economies since the 1950s, and more recently they have come to be increasingly used to direct credit towards environmentally sustainable economic activities. For example: ●●

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I­n July 2021 the People’s Bank of China announced it would provide funding to commercial banks to offer discounted loans (at an annual interest rate of 1.75 per cent) to companies making ‘significant impacts on emission reductions’.4 In December 2021, the Bank of Japan announced a new lending facility that will provide funds to financial institutions at zero interest for lending to sectors and firms that address climate change.5

Secondly, mandatory or minimum credit quotas require banks to allocate a fixed percentage of their loan portfolio to a specified sector. These are also referred to as credit floors, lending requirements or window guidance. Minimum credit quotas are most often implemented in the form of a priority sector lending programme, where the central bank determines minimum credit quotas and requires commercial banks to lend a specific percentage of their overall lending to specific sectors. Maximum credit ceilings or quotas are used to limit bank lending to less economically desirable sectors or industries of the economy. Whereas minimum credit quotas might be applied to areas such as renewable energy projects, maximum credit quotas would limit lending to carbon-intensive sectors. Quotas have been deployed in some countries, including Bangladesh and India, to direct credit towards green and sustainable sectors.

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CASE STUDY Reserve Bank of India Priority Sector Lending Programme6 The Reserve Bank of India’s (RBI) Priority Sector Lending Programme (PSL) is designed to support the Bank’s and Indian Government’s objective of allocating credit to support key areas for growth and address social priorities. Originally, the PSL sought to ensure that 40 per cent of commercial bank lending supported priority sectors, including agriculture, infrastructure, education, microbusinesses and SMEs. In 2012, the RBI identified clean energy as an emerging priority, and the PSL guidelines were revised to include commercial loans for renewable energy solutions, particularly solar power generation. In 2015, a wider range of renewables were incorporated within the guidelines, including biomass-based power generators, wind turbines, small scale hydroelectric plants and remote village electrification. In 2020, the PSL guidelines were further updated to support lending to the agricultural sector for the installation of solar power and bio-gas plants.

Thirdly, central banks can influence credit allocation through differentiated reserve requirements. A reserve requirement is the share of reserves that private sector financial institutions must hold with the central bank relative to their total assets. Reserve requirements have a significant impact on banks’ ability to create credit. If the central bank lowers the reserve requirement, financial institutions can increase their lending; if the reserve requirement goes up, lending is constricted. Allowing a differentiated (lower) reserve requirement for ‘green’ assets is another way to incentivize credit allocation towards environmentally sustainable sectors. In 2018, for example, the People’s Bank of China announced it would accept green bonds and green loans as eligible collateral in its Medium-Term Lending Facility, allowing financial institutions posting eligible green collateral to increase their lending. This seems to have been a success, leading to a significant increase in green bond issuance from Chinese financial institutions following its introduction. There are, however, some concerns that not all these bonds were truly ‘green’ – some, particularly earlier issues, were issued to finance cleaner coal power generation, which would not seem to be compatible with environmental sustainability.

Risk weightings In response to the Global Financial Crisis in 2008, many central banks in advanced economies introduced macroprudential policy tools aimed at preventing an excessive

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build-up of systemic risk in the financial system. These have often taken the form of higher capital requirements for institutions seen as posing a significant risk to overall financial stability (e.g. large global banks and insurers), or higher risk weightings for sectors such as real estate, where excessive lending may, in the view of policymakers and regulators, pose particular risks to financial stability. A higher risk weighting means that a bank needs to hold more capital against a loan to a particular sector or firm, reflecting the higher risk associated with that lending. Some analysts have explored how macroprudential policies could be used to guide lending and investment towards environmentally sustainable sectors and firms, for example, by imposing higher risk weightings for carbon-intensive sectors or firms (a ‘brown penalty factor’) or by a ‘green supporting factor’ favouring low-carbon assets. Whilst these are still largely only on the drawing boards of central banks and regulators, some institutions are beginning to signal that they may consider their introduction, and/or encourage financial institutions themselves to introduce them in their internal risk models. In June 2021, for example, the Governor of Bank Negara (the Malaysian Central Bank), announced that: Over the last two years, we have been actively encouraging improvements in how financial institutions consider climate risk in their risk management approaches. We know that it will take some time before we see greater uniformity in approaches and while we would prefer not to dictate practices, we see a clear need to reduce the substantial divergence currently observed across institutions. The Bank is exploring various options to encourage better risk management approaches by outlier institutions – including through Pillar 2 capital requirements and supervisory assessments to reflect an inadequate consideration of climate risks.7

S­imilarly, as the European Commission continues to develop the EU’s European Green Deal, it has asked the European Banking Authority (EBA) to assess whether additional capital charges might be justified to reflect the higher risks of institutions holding high-carbon assets, and the effects of these on financial stability and bank lending. The Bank of England has also signalled that, in the future, it might be prepared to impose additional capital charges where institutions have significant exposure to climate and environmental risks.8 Previously, in December 2017, the EU Commission announced that it was considering the introduction of a ‘green supporting factor’ as it developed its Action Plan for Financing Sustainable Growth. This would lower banks’ capital requirements for environmentally sustainable lending and investments, accelerate the EU’s ‘green economy’ and help the bloc meet its (then) targets for cutting carbon emissions by 40 per cent from 1990 levels by 2030. Capital relief might be granted, for instance, for green bonds, green loans and green mortgages aligned with environmentally

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sustainable activities as set out in the EU Taxonomy, making these more attractive relative to lending to other sectors and firms. More details on the EU Commission’s 2017 proposals are outlined in the reading below; at the time of writing, the Commission had not moved forward with its proposals because it was awaiting the introduction of the EU Taxonomy, and this is now being further considered in the context of the European Green Deal. The converse of a ‘green supporting factor’ is a ‘brown penalty factor’ (i.e. a higher capital weighting) for lending to high-carbon, environmentally damaging sectors such as coal. It may be more difficult politically to introduce a penalty on legacy assets and investments, however, than to encourage investment in new, green and sustainable assets. Where financial institutions perceive that, because of physical and transition climate risks, lending to high-carbon sectors is riskier, many central banks and financial regulators already expect internal risk weightings to take account of this by requiring more capital to be held against these.

READING Green doesn’t mean risk-free: why we should be cautious about a green supporting factor in the EU9 The European Commission announced this week (December 2017) that the EU is considering lowering capital requirements for sustainable financial products. This means that, in future, EU financial regulators would treat green investments as less risky than carbon-intensive investments. So banks would need to hold less capital to buffer themselves against potential losses. The announcement comes as part of the Commission’s efforts to support sustainable finance and take action on climate change. Creating incentives for banks and financial markets to make investments in green assets sounds advantageous for the green economy. However, using regulations designed to reduce risk in the financial system to mobilize investment should be approached cautiously. A ‘green supporting factor’ would mean banks have less buffer against losses In their July 2017 report, the High-Level Expert Group on Sustainable Finance (HLEG), which reports to the Commission on the opportunities and challenges of sustainable finance, raised the possibility of a ‘green supporting factor’. The regulation is designed to boost green investment, but the HLEG noted multiple drawbacks. The amount of risk banks have to factor in when making different types of investments is called ‘risk-weighting’. A higher risk-weighting means a bank needs

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to have more capital to insulate it from potential losses if an investment fails. These regulations are designed to make banks more resilient. Their aim is to avoid another financial crisis where governments have to bail out banks to keep them from failing. A ‘green supporting factor’ would mean banks need to hold less capital when making green investments because those investments would have a lower riskweighting. The Commission hopes that this would encourage sustainable investment, because some European banks have responded to higher capital requirements by reducing lending. Some banks have been lobbying for the Commission to cut risk-weightings for green assets rather than increase them for carbon-intensive ones, because requiring them to hold more capital to buffer risks can lower their profits. But with less lossabsorbing capital, banks will also be more vulnerable if their investments fail. Using risk-weightings to motivate investment should be approached with caution. Green isn’t necessarily safer than brown In the long term, the shift to a low-carbon economy means there will be significant changes to areas like energy generation. As with every kind of technological shift, there will be winners and losers in low-carbon sectors and in carbon-intensive ones, and it’s not easy to predict who the winners will be. For instance, since 2015, more than 200 North American oil and gas companies have declared bankruptcy (mainly due to low oil prices), but so have more than 100 US and European solar companies between 2011 and 2015. In contrast, oil majors like Shell and Exxon Mobil have weathered low oil prices by increasing production efficiency and reducing overhead costs. The shift to low-carbon energy generation will have wider-reaching effects than low oil prices. Some companies may be able to adapt by diversifying their business operations. So it is not a foregone conclusion that the oil and gas sector will disappear, particularly as oil and gas will continue to be part of the energy mix during the transition to low-carbon energy. In the announcement, the Vice-President of the European Commission mentioned housing as one of the first areas that could qualify for lower risk-weightings. Efficient homes have lower energy costs. In theory, by spending less on energy, green homeowners are better able to repay their mortgage. This makes the risk of them defaulting on payments lower. However, there is little empirical evidence for this – just one study from the United States. This lack of evidence suggests it is premature to conclude that green mortgages are categorically lower risk than standard mortgages. More data and research in the EU is needed, and we should be particularly cautious since European banks may already be exposed to risk from overheated property markets. The case for a brown-penalizing factor is stronger. The financial sector is likely not taking proper account of the climate change risks associated with carbon-intensive

Central and development banks

assets. Increasing the risk banks need to account for in making carbon-intensive investments could go some way towards correcting this. However, there is still considerable debate about what the right level of risk-weighting would be. There is also discussion over whether other policy tools would be better suited to addressing the risk. More research is needed before moving to concrete policy proposals. There is no clear evidence that lowering risk-weightings will encourage greater investment Although the primary purpose of risk-weighting is to reduce the exposure of banks to risk, the Commission has used risk-weighting in the past to try to encourage investment. However, there’s no clear evidence that reducing capital requirements on investing in green assets will boost lending to green projects. The European Commission introduced a ‘Small to Medium Enterprise (SME) supporting factor’ to decrease the risk-weighting for loans to SMEs. The aim was to encourage banks to lend more. However, there is little evidence that the SME supporting factor has been effective. The European Banking Authority’s initial assessment of the policy did not find evidence that it had significantly decreased borrowing costs or increased access to finance for SMEs. In addition, interviews carried out by the Cambridge Institute for Sustainability Leadership with regulators and bank practitioners found that capital requirements only had a marginal impact on investment decisions for green projects. Other studies support the view that capital requirements do not significantly constrain bank lending across the economy. Without robust evidence for a green supporting factor, the Commission and HLEG should look for other avenues to increase green investment. Giving in to bank lobbying could send the wrong signal to the financial sector. By supporting an unproven regulatory tool without a robust evidence base, the European Commission could risk damaging the reputation of the concept of sustainable finance as a whole. Instead of trying to increase the flow of finance towards green assets by hook or by crook, increasing investment should be approached in the light of existing evidence. Regulators can increase the resilience of the financial system through a better understanding of climate risks. The HLEG should focus on identifying the most effective policies for scaling up green finance, rather than the most politically palatable or convenient ones.

QUICK QUESTION What is your view on introducing higher risk-weightings for lending to environmentally damaging sectors and firms? Can these be justified?

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Microprudential regulation and firm supervision Microprudential regulation refers to the supervision of individual financial institutions to ensure they operate in a safe and sound manner, are resilient to changes in economic conditions and external shocks, and maintain adequate capital and liquidity to remain solvent. As we noted above, in many cases central banks are financial regulators, too, and are responsible for supervising financial institutions (especially banks and insurers) in their respective jurisdictions. As we discussed in Chapter 5, the identification and disclosure of climate risks and stranded assets has become a priority for financial regulators due to the potential impact of climate risks on financial institutions’ resilience and solvency. Acute physical risks, such as flooding or tropical storms, may impose direct costs in the short term on businesses, individuals and communities, and the financial institutions exposed to them (for example, by disrupting production or supply chains, or by leading to claims against insurance policies). The chronic physical risks, transition risks and liability risks arising from climate change can significantly affect organizations’ business models, as well as individuals’ and communities’ resilience and finances, in the medium and long term. In turn, banks, investors, insurers and other institutions exposed to these risks will face increased costs and other charges. As we have discussed in earlier chapters, financial institutions whose strategies are overly reliant on sectors, firms, countries and regions that are highly dependent on fossil fuels, high-carbon means of production and distribution and/or are particularly vulnerable to the physical impacts of climate change may suffer from asset impairment and stranding that could, in extremis, threaten their solvency. This could impact financial stability overall, especially if several major financial institutions follow similar strategies and therefore are all impacted. For these reasons, central banks and financial regulators are adopting an increasingly harmonized approach to the microprudential regulation of climate and environmental risks, coordinated through bodies such as the FSB and NGFS, in areas including: ●●

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requiring financial institutions to identify and disclose their exposure to climate and environmental risks (usually aligned with the TCFD’s recommendations, which we examined in Chapter 5); r­unning stress tests to model financial institutions’ resilience to climate change, based on climate scenarios such as those developed by the NGFS (summarized in Chapter 5); and enhancing financial institutions’ governance and management of climate and environmental risks, including the incorporation of these into risk appetite frameworks, ensuring that boards exercise oversight of climate and environmental risks, and requiring firms to clearly assign responsibility for these to competent individuals and teams.

Central and development banks

CASE STUDY European Central Bank supervisory expectations on climate and environmental risks10 In May 2020, the European Central Bank (ECB) published guidance setting out its expectations for financial institutions relating to the effective disclosure and management of climate and environmental risks. These are not – at this stage – mandatory, but serve as a basis for regulatory dialogue, signposting the direction of travel the ECB expects from the institutions it regulates. The ECB expects financial institutions to consider climate-related and environmental risks – as drivers of established categories of prudential risks – when formulating and implementing their business strategies, governance and risk-management frameworks. Firms are expected to run internal stress tests to measure and monitor their financial exposures to such risks. The ECB believes this will help financial institutions assess the resilience of their business models, understand potential impacts on current and future investments and – perhaps most importantly – consider how climate risks could challenge their capital adequacy and liquidity. The ECB also expects financial institutions to become more transparent by enhancing their climate-related and environmental disclosures. Overview of the ECB’s supervisory expectations 1 Institutions are expected to understand the impact of climate-related and environmental risks on the business environment in which they operate, in the short, medium and long term, in order to be able to make informed strategic and business decisions. 2 When determining and implementing their business strategy, institutions are expected to integrate the climate-related and environmental risks that impact their business environment in the short, medium or long term. 3 The management body is expected to consider climate-related and environmental risks when developing the institution’s overall business strategy, business objectives and risk management framework, and to exercise effective oversight of climate-related and environmental risks. 4 Institutions are expected to explicitly include climate-related and environmental risks in their risk appetite framework. 5 Institutions are expected to assign responsibility for the management of climaterelated and environmental risks within the organizational structure in accordance with the three lines of defence model.

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6 For the purposes of internal reporting, institutions are expected to report aggregated risk data that reflects their exposures to climate-related and environmental risks, with a view to enabling the management body and relevant sub-committees to make informed decisions. 7 Institutions are expected to incorporate climate-related and environmental risks as drivers of existing risk categories into their existing risk management framework, with a view to managing, monitoring and mitigating these over a sufficiently long-term horizon, and to review their arrangements on a regular basis. Institutions are expected to identify and quantify these risks within their overall process of ensuring capital adequacy. 8 In their credit risk management, institutions are expected to consider climaterelated and environmental risks at all relevant stages of the credit-granting process, and to monitor those risks in their portfolios. 9 Institutions are expected to consider how climate-related and environmental events could have an adverse impact on business continuity, and the extent to which the nature of their activities could increase reputational and/or liability risks. 10 Institutions are expected to monitor, on an ongoing basis, the effect of climaterelated and environmental factors on their current market risk positions and future investments, and to develop stress tests that incorporate climate-related and environmental risks. 11 Institutions with material climate-related and environmental risks are expected to evaluate the appropriateness of their stress testing, with a view to incorporating those risks into their baseline and adverse scenarios. 12 Institutions are expected to assess whether material climate-related and environmental risks could cause net cash outflows or depletion of liquidity buffers and, if so, to incorporate these factors into their liquidity risk management and liquidity buffer calibration. 13 For the purposes of their regulatory disclosures, institutions are expected to publish meaningful information and key metrics on climate-related and environmental risks that they deem to be material, with due regard to the European Commission’s Guidelines on non-financial reporting. Further information is available free of charge on the ECB’s website.

In a similar manner, in 2021 the European Banking Authority (EBA) published proposals for integrating what it terms ‘ESG factors’ and ‘ESG risks’ into its regulatory and supervisory framework.11 The EBA’s proposals include recommendations for institutions to incorporate consideration of ESG risks into their governance structures, decision making and risk management, and to use scenario analysis to support

Central and development banks

longer-term resilience planning. In addition, regulators are encouraged to extend their time horizons for stress testing and other supervisory activities to at least 10 years in order to better capture physical and transition risks. Stress testing An important supervisory tool used by central banks and regulators is stress testing. Following the Global Financial Crisis in 2008, many central banks and regulators introduced stress testing to model the resilience of financial institutions, and the financial sector overall, against different economic scenarios and external shocks. In recent years, some institutions have begun to include climate change scenarios in stress tests, assessing the resilience of financial institutions’ (usually banks and insurers) balance sheets to different climate change pathways, significant environmental shocks, and the impacts of physical and transition risks under different scenarios. Many central banks and financial regulators use the scenarios developed by the NGFS, described in Chapter 5, as a basis for their stress tests.

CASE STUDY Bank of England Biennial Exploratory Scenario on the Financial Risks from Climate Change12 The Bank of England conducts annual stress tests to assess the resilience and solvency of financial institutions under a range of scenarios. It supplements these annual stress tests with ‘Biennial Exploratory Scenarios’ (BES) designed to investigate a range of other risks that may not be directly linked to prevailing economic or financial conditions. The Bank’s 2021 BES has been developed to test the resilience of large UK banks, life insurers and general insurers – and the financial system overall – to the physical and transition risks associated with different climate scenarios. Three climate scenarios have been developed, based on the ‘Orderly’, ‘Disorderly’ and ‘Hot House World’ scenarios published by the NGFS: ●●

Early policy action (EPA): The transition to a carbon-neutral economy starts in 2020 and continues through to the end of the scenario in 2050. Carbon prices rise, other policies intensify gradually and the mean global temperature increase does not exceed 1.6°C (relative to pre-industrial levels) by the end of the century. There will be some increase in the frequency and severity of physical perils such as flooding, but the overall level of physical risk remains subdued. The Bank expects the effect on global GDP to be moderate (although there will be some regional variation). There will be significant variation in sectoral Gross Value Added (GVA) paths associated with the major transition in how energy, and goods and services in general are produced.

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Late policy action (LPA): The transition is delayed until 2030 and must be more sudden and substantial in order to ensure that the mean global temperature increase stays well below 2.0°C (relative to pre-industrial levels) by the end of the century. The Bank expects this to result in material short-term macro disruption. It is likely to feature a large fall in GDP, as well as falls in property prices, equity prices and changes in interest rates. Transition policies and sectoral GVA paths will continue to be important in this scenario, but macroeconomic paths should also drive results. Physical risks will be the same as in the EPA scenario. No additional policy action (NAPA): No policy action beyond that which has already been enacted is delivered. Thus, the transition is insufficient for the world to meet its climate ambition, and global temperatures increase by more than in the other scenarios, leading to severe physical risks. The mean global temperature increase exceeds 4°C (relative to pre-industrial levels) by the end of the century. This stress will materially lower trend growth rates, especially at the global level, and will affect a range of asset prices. A combination of physical risk and macroeconomic variables will be needed to measure the total impact on participants’ balance sheets. There is also variation in sectoral Gross Value Added (GVA) paths, reflecting the different extent of exposure to physical risks across different sectors. In the absence of a rapid transition, some physical risks will crystallize in the period to 2050, but the largest material shocks will occur later in the century.

Recognizing the challenges faced by financial institutions in identifying, measuring and modelling climate risks, the Bank of England notes that it intends the 2021 BES to be a ‘learning exercise [that] will develop the capabilities of both the Bank and . . . participants’. It will not be used to adjust capital requirements for participating institutions. The results of the 2021 BES were published in May 2022, and are summarized in Chapter 5.

Developing and promoting green and sustainable finance guidelines, frameworks and initiatives. In their role at the centre of the global and national financial systems, central banks are in a powerful position to promote and mobilize green and sustainable finance through their advocacy, research, participation in and support for international and national initiatives to develop standards, guidelines and frameworks.

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We have introduced and examined many of these elsewhere in this book, including, but not limited to: ●●

the Task Force on Climate-related Financial Disclosures (TCFD)

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the Taskforce on Nature-related Financial Disclosures (TNFD)

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the Network for Greening the Financial System (developing climate scenarios for use by central banks and other financial institutions for scenario analysis)

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the Green Bond Principles (and national green bond guidelines and frameworks)

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the Green and Sustainability Linked Loan Principles

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i­nitiatives to harmonize sustainability standards (such as the new International Sustainability Standards Board)

In many countries, central bank-led green and sustainable finance guidelines have begun to emerge, developed by central banks and financial regulators themselves or often in cooperation with finance sector bodies and other stakeholders. China is a good example of this, as summarized in the short case study below.

CASE STUDY The People’s Bank of China and green finance13 The People’s Bank of China (PBoC) has become a central agent in mainstreaming green and sustainable finance in China by working with other governmental organizations and the finance sector on various measures to develop comprehensive green banking guidelines. It has also developed a high profile internationally in this area through cooperation with other central banks, governments and international organizations, including the UNEP. In 2006, the PBoC created a countrywide credit database for disclosing information on credit and administrative penalties and on the environmental compliance of firms. In July 2007, the PBoC, the Ministry of Environmental Protection and the China Banking Regulatory Commission jointly launched China’s Green Credit Policy. This was a principles-based approach which recommended that banks include environmental compliance and risk assessment as criteria to be considered in the loan origination process, with the overall aim of reallocating credit from highpolluting, energy-intensive firms towards greener projects. In 2012, the China Banking Regulatory Commission (CBRC) strengthened this system by issuing Green Credit Guidelines, and in 2014 this was complemented by a Green Credit Monitoring and Evaluation mechanism and a Key Performance Indicators Checklist.

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The PBoC has also been involved in developing the domestic green bond market. In 2015 it introduced the first official green bond guidelines in China – the ‘Green Bond Endorsed Project Catalogue’. In 2020, an updated Catalogue was issued, which classifies eligible green projects in six areas: ●●

Energy saving and environmental protection

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Clean production and manufacturing

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Clean energy

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Ecology and environmental sectors

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Green infrastructure upgrades

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Green services

In addition, central banks can use their soft power to promote the development of new green and sustainable market segments or products and nurture sustainable financial market practices. For example, by including climate and other environmental challenges in their policy and regulatory strategies and priorities, central banks can signal the importance of these to market actors. Central banks can ‘lead by example’ by disclosing their climate-related risks, with the Bank of England and De Nederlandsche Bank (the Dutch central bank) having already done so. In December 2021, the Network for Greening the Financial System (NGFS) published new guidance to encourage and support more central banks in disclosing climate risks.14 Similarly, central banks are uniquely positioned to conduct and disseminate research on green and sustainable finance, since they have well-established research departments, access to market data, and (usually) a high profile to ensure that their research findings are strongly promoted. As the following reading demonstrates, though, while central banks may be very active in encouraging and promoting green and sustainable finance through their advocacy, research and networking activities, they may not at the present time be as active in embedding sustainability into their own core monetary and financial policy operations and activities.

READING The Positive Money Green Central Banking Scorecard15 In 2021, Positive Money, a think-tank and NGO that campaigns for ‘a banking system that enables a fair, sustainable and democratic economy’, set out a range of policies and activities that, in its view, the ‘ideal’ central bank should adopt to genuinely

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embed environmental sustainability into its strategy and operations. It then scored and ranked G20 countries on the policies and activities implemented by central banks and financial regulators, in four main areas: ●●

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Research and advocacy – the extent to which central banks deepen their understanding of climate and environmental risks and sustainable finance via research activities, and promote the importance of these issues across the financial sector and beyond. Monetary policy – whether central banks include sustainability within their monetary policy operations, such as asset purchase programmes as described earlier in this unit. Financial policy (prudential regulation) – the extent to which central banks and other financial regulators incorporate climate and environmental sustainability factors in their supervisory activities (which we examined in Chapter 5). Leading by example – whether and how central banks are greening their own institutions by disclosing their own exposure to climate risks, decarbonizing their portfolios and supporting initiatives to mobilize green and sustainable finance.

The Positive Money scorecard can be found here: http://positivemoney.org/wpcontent/uploads/2021/03/Positive-Money-Green-Central-Banking-Scorecard-Report31-Mar-2021-Single-Pages.pdf. As can be seen from this, while the majority of G20 central banks score highly in terms of Research and Advocacy, most score poorly in other areas. In particular, in Positive Money’s view, very few central banks have taken action to embed sustainability into their own monetary and financial policy operations. Positive Money concludes that their research and scorecard reveals: A universal absence of high-impact policies that target reductions in financial support for fossil fuel activities from all G20 central banks and supervisors. We consider this [. . .] to be the most important finding of this report, and we hope that the stark result is met with recognition from central banks and supervisors that publishing reports and giving speeches is not enough. As public institutions with mandates that cannot be fulfilled without environmental considerations, it is imperative that they clean up their act and step up the pace and scale of their green policymaking.

QUICK QUESTION Reflecting on Positive Money’s Green Central Banking Scorecard, what priority actions (if any) would you like the central bank in the country where you live take to promote sustainability?

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The role of development banks Development banks are international, regional and national public financial institutions tasked (usually) with promoting socio-economic development. Exact definitions vary, but for the purposes of this book we use the following definition from the World Bank: ‘A bank or financial institution with at least 30 per cent state-owned equity that has been given an explicit legal mandate to reach socio-economic goals in a region, sector or particular market segment.’16 They may sometimes be referred to as ‘international financial institutions’, ‘national/regional investment banks’ or similar. Development banks play an important role in promoting economic development in both developed and developing countries by providing finance and a wide range of advice and capacity-building programmes to sectors, organizations and communities whose financial needs are not sufficiently served by private commercial banks or local capital markets. Development banks often seek to ‘unlock’ lending and investment by commercial institutions, as we shall see below. Clients typically include SMEs, large private corporations and public bodies.

Overview of development banks Development banks vary widely in scale, and can take several different forms: ●●

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­ ultilateral development banks (MDBs), sometimes referred to as international M financial institutions (IFIs): Supranational institutions set up by sovereign states, who are their shareholders. Their remits reflect the development and cooperation policies established by these states, and often include developing countries. Examples of MDBs include the World Bank, the International Finance Corporation (IFC), the Asian Development Bank (ADB), the African Development Bank (AfDB), the Inter-American Development Bank (IDB), the European Bank of Reconstruction and Development (EBRD), the European Investment Bank (EIB) and the Asian Infrastructure Investment Bank (AIIB). National development banks (NDBs): Institutions created by national governments to provide financing for the purposes of economic development in the domestic economy. Some national development banks also provide financing for international development. NDBs tend to have in-depth local knowledge, as well as relationships with and understanding of domestic policy and markets. Examples of NDBs include the China Development Bank, the German KfW and the Scottish National Investment Bank (SNIB). Green development banks (GDBs): These are publicly owned entities, usually much smaller than MDBs and NDBs, established to facilitate private investment into mainly domestic low-carbon and climate-resilient infrastructure, and other

Central and development banks

environmental sectors such as water and waste management. GDBs have been established in countries including, but not limited to, Australia, Japan, Malaysia, Switzerland, the US and the UK (the UK’s Green Investment Bank was sold to the private sector in 2017). ●●

Export-import banks (or export credit agencies): Public agencies and entities that provide government-backed loans, guarantees and insurance to corporations from their home country that are seeking to do business overseas in developing countries and emerging markets. ECAs provide loans or guarantees, and can also underwrite risks entailed by investments in overseas markets. Examples of ECAs include the Export-Import Bank of China, the Export-Import Bank of the United States and UK Export Finance.

QUICK QUESTION Which development banks operate in the market(s) where you live and work? In what ways have they supported the growth of green and sustainable finance?

Multilateral development banks and sustainable finance Multilateral development banks (MDBs) have played and continue to play key roles in the development and growth of the green and sustainable finance market. Many have mitigating and adapting to climate change and other sustainable activities as key policy objectives, with the relative importance of this compared with other policy objectives (e.g. economic development) growing over the past decade. The European Investment Bank (EIB), for instance, issued the first green (‘climate awareness’) bond in 2007 and remains one of the world’s largest issuers, offering a wide range of green and sustainable finance products, including loans and equity investments. By the end of 2020, the EIB had issued green bonds totalling nearly €34 billion in 17 countries, including the first ‘Sustainability Awareness Bond’ in 2018, with proceeds earmarked for projects supporting the UN Sustainable Development Goals. In November 2020, the EIB made a major strategic commitment to aligning its activities with green and sustainable finance, and supporting the EU’s European Green Deal and other sustainable finance activities, with the publication of the Climate Bank Roadmap.17 This set out the EIB’s plans that: ●●

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lending to support climate action and environmental sustainability would exceed 50 per cent of the EIB’s overall lending activity by 2025 and beyond; and all of its financing activities would be aligned with the goals and principles of the Paris Agreement by the end of 2020, thereby ensuring that the EIB’s activities do no significant harm to the climate.

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In practice, the latter commitment meant the EIB would cease financing oil, gas and coal projects; the bank stated that it would do so by the end of 2021. The European Bank for Reconstruction and Development (EBRD) has financed some 2,000 green projects to the end of 2021 totalling €36 billion; they are estimated to have reduced annual greenhouse gas emissions by approximately 104 million tonnes CO2e.18 The EBRD recently launched its ‘Green Economy Transition’ strategy for the period 2021–25, which will increase its green financing to more than 50 per cent of the EBRD’s total annual financing by 2025. The bank’s strategy focuses on five key themes: energy and resource efficiency, renewable energy, climate resilience, the just transition and the circular economy. The EBRD is also an important issuer of green bonds known as ‘Environmental Sustainability Bonds’. The EBRD issued its first such bond in 2010 and, as of the end of 2019, had issued 92 Environmental Sustainability Bonds totalling €5.2 billion, supporting more than 350 sustainability projects. The Asian Development Bank (ADB) provided more than $40 billion of climate finance between 2011 and 2020, with a focus on cleaner infrastructure and technologies, conservation and forest management, building more resilient communities and helping communities adapt to the effects of climate change. In 2018, the ADB made a commitment that, by 2030, at least 75 per cent of its activities would support climate change mitigation and adaptation, supported by an $80 billion funding commitment. The bank’s ‘Strategy 2030’ describes addressing climate change, building climate and disaster resilience, and enhancing environmental sustainability as operational priorities.19 In 2019, the ADB announced that it had achieved the goal it set in 2014 of doubling its annual climate investments from $3 billion to $6 billion – one year ahead of its 2020 target. The African Development Bank (AfDB) is more focused on climate change adaptation and resilience than many other MDBs. Africa is not a major emitter of greenhouse gases, but is the continent most vulnerable to the effects of climate change, and many communities in Africa will be significantly impacted by global warming – through rising sea levels, large tracts of land becoming uninhabitable and the increased frequency and severity of extreme weather events such as droughts. The AfDB has a target of 40 per cent of its overall portfolio supporting climate finance, with equal weighting given to adaptation and mitigation. The bank also manages the Africa Climate Change Fund, whose current focus is on climate resilience and gender equality.20 The AfDB plays a leading role in developing the capacity of other institutions in Africa to embed sustainability into their activities. It works with central and national development banks, and in particular has stimulated the development of the green bond market in Africa, both through its own issues and by helping bring other issuers to market (e.g. the first Nigerian green bonds). While smaller than many of its peers, the Inter-American Development Bank (IDB) plays a key role in the financing of environmental sustainability (and broader aspects of sustainability, such as social inclusion) in the Caribbean and Latin and South

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America. The total amount of financing provided by the IDB in the period 2015–20 was approximately $1.5 billion, mainly focused on conservation and forest management, environmental management and governance, and climate change adaptation, resilience and disaster recovery.21 As well as financing and co-financing climate change adaptation and mitigation projects, though, a key focus for the IDB is capacity building – working with the region’s public sector institutions, particularly finance and planning ministries, to help them develop relevant expertise to lead national climate change and resilience activities and unlock investment to support these priorities. The World Bank Group, comprising the World Bank itself together with the International Finance Corporation (IFC) and the International Development Association (IDA), is the largest multilateral source of finance for climate investments in developing countries. It works alongside other MDBs, governments and a wide range of other public and private sector institutions to help coordinate a global response to climate change. The Bank’s 2016 Climate Change Action Plan set out an objective of increasing the proportion of climate finance in the Group’s overall financing activities from 21 per cent to 28 per cent, a target exceeded in 2018. By the end of 2020, the World Bank Group had provided more than $83 billion of climate finance to developing nations, including $21.4 billion in 2020 alone. The Bank’s second Climate Change Action Plan, covering the period 2021–25, commits to increasing this proportion to 35 per cent of overall financing, with half of the World Bank’s climate finance earmarked to support adaptation and resilience measures – giving this equal weighting to investments to reduce emissions (mitigation).22 Other priorities for the World Bank to 2025 include: ●●

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supporting transformative investments in key systems that contribute most to emissions and have the greatest vulnerability to climate change, including energy, food systems, transport and manufacturing; and helping countries and regions successfully transition from coal power to more sustainable sources of energy.

The World Bank Group also works with the other multilateral development banks (MDBs) to develop common approaches to monitor and track their climate finance flows to client countries as they increase their financing of climate change mitigation and adaptation activities. The MDBs are continuing to align their financial flows to help countries meet the Paris Agreement. They support the implementation of the NDCs and facilitate activities that transition development towards low greenhouse gas emissions and climate resilient development. In addition to climate finance, the World Bank also plays a key role in developing innovative approaches to combating climate change, facilitating the sharing of best practice and implementing joint projects by bringing together the scientific, financial, policy and other communities. The Bank has also helped to establish many of the international frameworks, organizations and networks supporting the transition to

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a low-carbon world, helps its client countries develop and implement their National Determined Contributions and has developed and published a wide range of tools and reports to assist organizations and policymakers with climate change and climate finance, such as its Climate and Disaster Risk Screening Tools and Climate Adaptation Country Profiles.

National development banks Whilst MDBs play a key role in mobilizing climate finance, and finance to support sustainable development more generally, they are supported by and often work with a wide range of national development banks (NDBs). In the past, NDBs were often established with mandates to finance public infrastructure investment and national/ sub-national economic development, but some now have mandates to also finance and co-finance investment in climate change mitigation and adaptation projects and activities, both in their domestic market and in developing countries. There are estimated to be some 250 NDBs in existence having approximately $5 trillion in assets, according to a 2016 study;23 however, just 10 of them (including those in China, Germany, Brazil, India and South Africa) account for nearly ­$3 ­trillion of this. At present, the mandates of these largest NDBs tend to include but are not necessarily fully focused on environmental sustainability. The authors of the study note that the assets of these 10 NDBs alone are twice the size of MDB assets, meaning that the largest NDBs can – and in some cases do – play a significant role in mobilizing green and sustainable finance, both domestically and in developing countries, through assistance programmes. In 2020, the Overseas Development Institute (ODI) surveyed NDB climate finance and published its key findings and recommendations. The ODI identified five key roles that NDBs can play in supporting climate change mitigation and adaptation: ●● ●●

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as financiers of low-carbon, climate-resilient infrastructure investment; a­s mobilizers of external finance, either private or public, for infrastructure investment; as intermediaries that blend international climate and public development finance with their own resources to help mobilize and scale up private investment; as policy influencers that can help shape broad and specific policy frameworks to encourage and channel private investment; and as pipeline developers that can identify and develop bankable projects and/or invest in demonstration projects and new technologies that demonstrate commercial viability.24

Some NDBs, such as the German Kreditanstalt fuer Wiederaufbau (KfW), have already adopted strong green mandates, making sustainable finance a key strategic priority. In 2020, for example, more than one-third of the KfW’s total financing was directed

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towards climate finance and environmental protection – approximately €45 billion. The KfW also reports its exposure to climate risk in alignment with the TCFD’s recommendations.25 As another example, the newly established Scottish National Investment Bank has adopted a ‘mission led’ approach, with one of the bank’s three missions being to support Scotland’s transition to net zero by 2045.26 The majority of NDBs, however, do not at present have mandates that include promoting environmental sustainability.

READING National development banks and financing the UN Sustainable Development Goals27 National development banks can play a decisive role in financing the Sustainable Development Goals and the transition to a low-carbon energy future. Given their size and potential, these financial institutions do not receive adequate attention in global financial or development discussions. For the sake of sustainable development, this must change. To achieve the SDGs, the United Nations estimates that an additional $2–$3 trillion of investment will be needed per year in energy, infrastructure, agriculture, health and education. Specifically, there remains an annual $1 trillion infrastructure financing gap to be filled, mostly in emerging economies. Relative to a $110 trillion global economy and over $100 trillion of assets of institutional investors in the Organization for Economic Cooperation and Development alone, this should be manageable. Yet, the critical question remains: what are the right financial institutions to intermediate saving for sustainable investments? National-level development banks are a major part of the answer. Development banks are financial institutions that provide long-term capital and advisory services for infrastructure projects, businesses, agriculture and other sectors whose financial needs cannot be served solely by the public sector, commercial banks or capital markets. They are very often publicly funded, or at least initially capitalized by public resources. They range from international institutions such as the World Bank and the Asian Development Bank, to national-level organizations like the China Development Bank, to subnational institutions such as the Chicago Infrastructure Trust or the Connecticut Green Bank in the United States. As these examples suggest, development banks are policy instruments that exist both in the developed and developing world, regardless of the level of economic development. Although much attention is given to global development banking institutions, such as the recently announced Asian Infrastructure Investment Bank, nationallevel development banking institutions will play an even more critical role in achieving the SDGs.

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National development banks have played a crucial role in economic development in Europe since the 19th century. In 1852, Crédit Foncier and Crédit Mobilier were launched in France to accelerate investments in agriculture and manufacturing. They were critical in helping Continental Europe catch up to Great Britain in the industrialization process. More recently, in the 20th century, national development banks helped former colonies mobilize long-term investments in their economies – from China to India to Ethiopia. National development banks come in all shapes, sizes and histories. A 2012 survey by the World Bank is quite illuminating. Out of the 90 development banks from 61 countries that responded to the survey, 39 per cent were founded between 1990 and 2011. They represented assets of over $2 trillion, with the China Development Bank, the Brazil Development Bank and Germany’s KfW all being larger than the World Bank itself. Over 70 per cent of NDBs are fully state-owned institutions, whereas others, including the Credit Guarantee Corporation of Malaysia, have part-private ownership. Despite the expansion of private sector investment vehicles and the general deepening on financial markets, development banks remain critical for two reasons: first, the need for public-private partnerships for infrastructure investments, regardless of location, and second, the growing shortage of long-term capital from commercial banks and capital markets due to changes in how pension funds and banks are regulated. First, national development banks must lead on building robust pipelines of bankable projects for infrastructure financing. Institutional investors – namely, sovereign wealth funds, insurance companies and pension funds – are looking to significantly increase their exposure to infrastructure assets, but are not finding enough opportunities to do so. This is a true public policy failure of global dimensions. National development banks can serve as the critical bridge between the planning of infrastructure investments by government and the proper structuring to crowd in private capital. They may be the only financial institutions that can serve as this bridge. Second, national development banks should guide local savings pools on how to support and invest in local sustainable development. This is a key modality that has not yet been analysed. The growing savings pools in the developing world must be used to finance domestic development, as opposed to purchasing overseas securities for the sake of diversification. National development banks should engage with domestic pension funds and insurance companies and come up with agreed-to targets for investments. Third, national development banks should lead on the transition to a low-carbon future. For high-income countries, this means aligning investment with long-term

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decarbonization strategies that include creating new financial instruments – including more aggressive credit guarantees and risk-mitigation products – that will attract private capital into low-carbon energy solutions and large-scale infrastructure. For low-income countries, this will mean aligning investment with climate adaptation plans. The growing number of Green Banks – ranging from the UK Green Investment Bank to the Malaysia Green Bank – shows how this can be done. Fourth, national development banks must build up their presence in the global financial and development discussions. A Global Development Banking Forum should be established, co-chaired by the World Bank and the Asian Infrastructure Investment Bank, with bi-annual meetings in Washington, DC and Beijing. Such an initiative would accelerate learning and idea sharing between the hundreds of national and subnational development banking institutions. The outcome of this could be tremendous. National development banks, when structured properly, embody exactly what is needed to finance sustainable development: public-private partnership and longterm capital deployment. Neither the public nor the private financial communities can do this alone. These institutions should be re-examined and elevated in importance to support the coming transition in our global economy.

Green development banks In addition to the activities of MDBs and NDBs summarized above, there are a rapidly growing number of dedicated ‘green development banks’ (GDBs) – sometimes simply referred to as ‘green banks’ – established to promote environmentally sustainable, climate-resilient development on (usually) a national or more local basis. These are usually publicly owned entities, and may be established at the national level (e.g. Australia, Japan, Malaysia, Switzerland, the US and the UK), the state level (e.g. California, Connecticut, Hawaii, New Jersey, New York and Rhode Island in the United States), and in some cases the county or city level (e.g. Masdar, United Arab Emirates). As noted above, the UK’s Green Investment Bank, established in 2012, was sold to a private sector consortium led by Macquarie in 2017, and is now known as the Green Investment Group. A 2020 report from the Rocky Mountain Institute, the Green Finance Institute and the Natural Resources Defence Council identified 27 operational GDBs, with a similar number in development/under consideration in 25 countries. In the period 2012–19, GDBs had committed a total $24.5 billion of their own capital and had unlocked an additional $45.5 billion of co-investment from the private sector.28 As with MDBs and NDBs, a variety of financing mechanisms, including long-term loans

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(usually on more favourable terms than available from the private sector), equity investments, grants and guarantees, are deployed to stimulate investment in environmentally sustainable projects and activities. Compared with the financing activities of MDBs and NDBs, the capital deployed and co-financed by GDBs is relatively small: in 2020 alone the German KfW provided funds totalling some €45 billion for climate finance and environmental protection, for example, substantially more than the total capital deployed by GDBs since 2012. The key role of many GDBs, though, is less in the provision of substantial amounts of capital and more in addressing perceived market failures (e.g. the failure to appropriately price climate risks and opportunities) and stimulating investment in new sustainable technologies, sectors and firms. A good example of this is the (then) UK Green Investment Bank’s Offshore Wind Fund, as the case study below illustrates.

CASE STUDY The UK Green Investment Bank’s Offshore Wind Fund29 In 2014, the UK Green Investment Bank (now the Green Investment Group) established the world’s first dedicated offshore wind fund with the aim of attracting new capital into the market in order to purchase already-operating offshore wind farms from developers. By attracting new liquidity into the market, the fund has helped reduce the long-term cost of finance and has enabled developers to sell down their stakes and use the proceeds to finance new projects. The Fund has been successful in attracting new and different investors to offshore wind, with assets under management now surpassing £1 billion. Investors in the Fund include a number of UK-based pension funds as well as international institutional investors, including one of the world’s largest sovereign wealth funds and a leading European life and pension company. The Fund’s portfolio consists of interests in six operational wind farms, namely: Sheringham Shoal, a 317 MW offshore wind farm located off the North Norfolk coast; Rhyl Flats and Gwynt y Môr offshore wind farms, both located off the coast of North Wales with total capacities of 90 MW and 576 MW, respectively; Lynn and Inner Dowsing wind farms, two adjacent operational wind farms with an aggregate installed capacity of 194 MW; and Lincs, a 270 MW wind farm located 5km off the Lincolnshire coast alongside Lynn and Inner Dowsing. Collectively, these projects have a capacity of 1.45 GW, producing over 4,500 GWh of renewable electricity each year, resulting in the avoidance of almost 2 million tonnes of greenhouse gas emissions annually.

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The role of development banks in mobilizing green and sustainable finance While most development banks are run on a commercial basis to make a profit or surplus, their overarching mandate is typically not to maximize profits to private shareholders (their shareholders are usually governments and other public sector institutions) but rather to promote and achieve a wider range of economic, social and environmental goals. In return, their public shareholders accept a lower rate of financial return. This enables development banks to take a longer-term perspective than private sector institutions (often more than 10 years) – referred to as ‘patient capital’  – and to assume higher risks, such as working in developing markets and supporting new technologies. By virtue of their scale, ownership structures and mandates, development banks are well placed to help scale up green and sustainable finance through several channels, both by deploying their own capital, and especially by ‘unlocking’ private capital to support their own lending and investment, often referred to as ‘blended finance’ or ‘co-financing’. This facilitates additional private lending and investment, often substantially more than that available from the development banks themselves, to be directed towards environmentally sustainable projects and investments. In 2019, for example, MDBs committed approximately $61.5 billion of climate finance from their own resources. Climate co-finance in the same year totalled $102.7 billion, with the total of MDB climate finance and co-financing therefore exceeding $160 billion.30 Development banks use a very wide range of financing mechanisms and tools, and MDBs in particular are often involved with the development of bespoke and/ or innovative public/private co-funding and blended finance mechanisms, as well as new financial products and services such as the first green bonds, or more recently the blue bonds described in Chapter 7. In general, however, the products and services deployed by development banks are designed to: a d  e-risk investments, unlocking private sector capital to invest alongside development banks’ lending and investment; b p  rovide equity investment or grant funding to finance promising new technologies, sectors or firms where this would not be available from private sources; and/or c provide technical and capacity-building assistance. We will look at these in more detail below. Many development banks combine instruments to support projects at both the pre-investment stage (by providing technical assistance, grants, etc.) and the investment stage (with, for example, concessionary loans and guarantees) to attract co-financing from sources of private capital.

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Concessionary loans Concessionary loans are provided at more favourable conditions than those offered by private financial institutions, and can be in the form of zero or lowerthan-market interest rates, lower collateral requirements, longer loan tenors and extended repayment schedules. The degree of concessionality can be adjusted to the needs of a particular project, from highly concessional to just below market terms, depending on the balance between the commercial and impact returns sought by the lender(s). Concessionary loans can be used to help develop new markets or policy goals as they address the high cost associated with early market entrants. Used effectively, concessionary loans can pave the way for future projects in the sector to be financed on fully commercial terms. Thus, concessionary loans can be an effective way to nurture emerging green and sustainable sectors. They would not normally be used where the goal is to unlock private sector lending, as the concessionary nature of the loans means that commercial banks would be unable to offer similar terms. Rather, the aim is to provide funding for new sectors and business models where commercial returns are yet to be proven.

CASE STUDY The Clean Technology Fund31 The $8 billion Climate Investment Funds (CIF), a multilateral fund operated by the World Bank, aims to accelerate climate action by empowering transformations in clean technology, energy access, climate resilience and sustainable forests in 72 developing and middle-income countries. The CIF’s large-scale, low-cost, long-term financing lowers the risk and cost of climate financing. It tests new business models, builds track records in unproven markets and boosts investor confidence to unlock additional sources of finance. The CIF encompasses four different programmes: the Clean Technology Fund (CTF), the Scaling-Up for Renewable Energy Program in LowIncome Countries (SREP), the Pilot Program for Climate Resilience (PPCR) and the Forest Investment Program (FIP). The Clean Technology Fund The $5.5 billion Clean Technology Fund (CTF) was established to provide scaled-up financing to developing countries for the demonstration, deployment and transfer

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of low-carbon technologies having significant potential for long-term greenhousegas emissions savings. The objectives of the CTF are to finance transformation through large-scale financing of low-carbon technologies and innovative business models in energy efficiency, renewable energy and sustainable transport, while providing experience and lessons in responding to the challenge of climate change through learning-by-doing. The CTF portfolio encompasses large-scale investments in 15 middle-income countries, in areas including: energy efficiency in industrial, commercial and residential sectors; renewable energy technologies ranging from solar to geothermal, wind and biomass; and sustainable urban transport for public transit, hybrid buses and green logistics.

Bespoke loan products Many development banks have set targets around the volume of green and sustainable lending. As noted previously, the European Investment Bank (EIB), for example, allocates 50 per cent of overall lending to support climate change and environmental sustainability, whilst Green Development Banks (GDBs) have specific mandates in these areas. To assist with the achievement of these targets, some development banks have developed bespoke products or loan programmes designed to meet the needs of specific customers and sectors, and/or address particular environmental issues. These products are typically only available for investments that meet certain green and sustainable criteria. One example is the Sustainability-Linked Loan with Engagement Dialogue programme offered by the Development Bank of Japan (DBJ),32 based on the Loan Market Association’s Sustainability Linked Loan Principles (SLLP) described in Chapter 6. The programme’s features are similar to those of commercial sustainability-linked loans, but also include additional concessionary features that would not be viable in the private sector. The DBJ uses dialogue to support borrowers in setting environmental and other sustainability-related performance targets (SPTs), and in reporting publicly on achievement. In some cases, close alignment between development banks and government policy has created a powerful synergy between policy, regulation and financing, coordinated for maximum impact. New government policies have been complemented with new financing instruments in order to transmit policy objectives more efficiently. One example is the major role that the KfW has played in the greening of Germany’s economy through the Federal Government’s ‘Energiewende’ policy.

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READING KfW and the Energiewende33 Kreditanstalt fuer Wiederaufbau (KfW) is a German development bank established shortly after World War II. Although initially established to support post-war restructuring, the KfW is now involved in a wide range of activities and operates internationally as well as throughout Germany. The organization of the KfW’s operations has changed over the years, and today activities are focused on three priority ‘megatrends’: ●●

climate change and environment

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globalization and technical progress

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demographic development

The KfW’s history of investing in energy efficiency and environmental protection dates back to the 1970s, but it was in the 2000s that its activities accelerated, following the passing of a series of laws promoting renewable energy. This culminated in 2011 with the German Federal Government’s ‘Energiewende’ initiative, which set the goal of phasing out nuclear power sources and of having renewable energy sources meet 60 per cent of Germany’s gross final energy consumption by 2050. In response, the KfW launched a suite of new financial products. Among these was a loan programme targeted at larger companies to promote the adoption of a range of cleaner technologies that would use at least 15 per cent less energy, and a programme of lending and investment to the renewable energy sector. The ‘Renewable Energies’ and ‘Offshore Wind’ programmes provided low-interest loans and long-term financing for building new power stations and modernizing existing ones. In 2015 and 2016, the KfW financed nearly half of all lending to the renewables sector in Germany, with approximately €15 billion of funding deployed to support the expansion of renewable energy in the country, including lending to the sector totalling €10 billion. Some results of the KfW’s activities in 2015 and 2016 include: ●●

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The renewable energy systems financed by the KfW reduced greenhouse gas emissions permanently by a total of 9.5 million tonnes of CO2e per year. A further 0.3 million tonnes of CO2e per year was avoided by systems financed abroad over the same period. The renewable energy systems allowed Germany to avoid energy imports worth a total of around €550 million each year, amounting to some €11 billion in savings over a 20-year period.

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The reductions in greenhouse gas and other emissions from the projects financed in Germany prevented an estimated €960 million in climate change and environmental damage. The manufacture and construction of the renewable energy systems (excluding offshore wind energy) secured or created approximately 89,000 jobs in Germany for a year, with some 2,700 jobs created each year for system operation and maintenance.

Partial risk and credit guarantees A guarantee is when one party commits to being responsible for all or part of the debt upon an event that triggers such a guarantee, such as a loan default. Guarantees enable a transaction to move forward by transferring the risk from a (usually) private sector lender unable or unwilling to bear it to another that will – often, in the case of climate and sustainable finance, a development bank such as the World Bank. By reducing the risk to private sector lenders and investors, guarantees support the growth of green and sustainable finance by improving a project’s credit profile and unlocking private finance to achieve the risk/return profile needed to justify lending and investment. This can be particularly important in countries where political instability and/or a lack of stable institutions and legal certainty significantly increases investment risk. Two main types of guarantees are available in this area: ●●

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Partial risk guarantee (PRG): Protects a lender against the risk of default when this is caused by a government’s failure to meet its obligations related to a specific project or activity to which it is committed (these are sometimes referred to as ‘political risk guarantees’). Partial credit guarantee (PCG): A credit enhancement mechanism for bonds and loans designed to insure against non-payment by a borrower for any reason – political, commercial or otherwise. By promising to pay the principal and/or interest up to a (usually) pre-determined amount, credit guarantees improve a project’s credit profile, catalysing a wider array of investor interest and better credit terms.

Guarantees tend to be ‘partial’, meaning that they do not cover the entire amount borrowed, but only the amount necessary to ensure that the transaction proceeds. The rationale behind this is that by not covering the full amount, the guarantee does not generate moral hazard, and ensures that the private sector lender or investor still has an incentive to undertake due diligence on the viability of the borrower and use of resources.

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CASE STUDY The International Finance Corporation’s CHUEE programme34 Due to its rapid economic growth, China’s burgeoning energy demand has created significant challenges to its energy security and sustainable development. In the face of this dual challenge, the country’s leaders have emphasized energy efficiency as a top priority. From 1980 to 2000, China reduced its energy intensity, as measured by energy use per unit of gross domestic product, by an average rate of about 5 per cent per year. These results were achieved mainly through subsidies and regulations geared towards China’s substantial industrial sector. However, by the early 2000s this trend had reversed due to rising domestic energy consumption, a rapid increase in the production and export of energy-intensive goods, and an expansion in construction. China worked to increase private sector investment in energy efficiency, but had limited success because financial institutions lacked experience in dealing with energy efficiency projects. Lending decisions were based mostly on the value of asset collateral (balance sheet financing) rather than on expected projectbased cash flow (project financing), which hindered the ability of energy service companies to access credit. In 2004, China turned to the International Finance Corporation (IFC) for help in designing a new private sector-based finance initiative for energy efficiency. This effort led to the creation of the China Utility-Based Energy Efficiency Finance Program (CHUEE), a new risk-sharing mechanism meant to increase the availability of private investment for energy efficiency projects. CHUEE set an initial target of reducing emissions by 8.6 million tonnes of carbon dioxide (CO2) per year by 2012 under a base case scenario, which was later increased to 13.6 million tonnes of CO2 per year by the end of the second phase in 2015. CHUEE supports the implementation of energy efficiency improvements in two major ways. First, it provides a risk-sharing facility through partial credit guarantees to local banks for qualified energy efficiency loans. Second, it provides technical assistance to relevant stakeholders, including banks, energy service companies and end-users. In addition to these two major activities, CHUEE engages in market outreach through information dissemination. Through the first two phases of the programme, the IFC committed $207 million for the risk-sharing facility. This support is leveraged by a $16.5 million grant from the Global Environment Facility to cover the initial losses of the guarantee, as well as by donations from the Government of Finland ($4 million) and the Government of Norway ($3 million). The funds are used to support three major private financial institutions in China. The Industrial Bank was the first bank to participate. Its focus is on lending

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to large industrial corporations, and it has been the primary recipient of CHUEE guarantees. The Bank of Beijing and the Shanghai Pudong Development Bank also joined the pool of private investors, in 2007 and 2009, respectively. The risk-sharing facility of CHUEE guarantees commercial banks’ green loans to energy service companies and end-users. These loans include efficiency projects such as power generation from gas and heat recovery, biogas production from waste, and the optimization of various industrial processes. Initially, guarantees were structured such that, for the first 10 per cent of losses (the first loss tranche in a commercial bank’s guaranteed portfolio of loans) CHUEE covered 75 per cent of the risk while the commercial partner covered 25 per cent. For the remainder of losses, CHUEE covered 40 per cent while the commercial bank covered the remaining 60 per cent. This was restructured in 2008 such that CHUEE would cover 50 per cent of the risk for the first 5 per cent of losses. This risk-sharing structure is a departure from previous privately operated credit guarantee systems in China, which commonly covered 100 per cent of the credit risk at the outset. Since the traditional guarantee system effectively negated credit risk to banks, it provided little incentive for them to undertake detailed risk analyses or understand the nuances of the projects they supported. Consequently, most lending institutions failed to learn about innovative concepts such as energy performance contracting or project-based cash flow as collateral. CHUEE addressed this problem by requiring participating banks to take on some credit risk from the outset in order to improve their familiarity with energy efficiency project finance. Past international experience has shown that guarantees alone are not sufficient to encourage private investment in energy efficiency. CHUEE addresses this problem by including technical assistance as a core component of its strategy. For banking institutions, assistance involves education about the financial returns of energy efficiency projects, as well as training on credit risk management practices. For product and service providers and end-users, CHUEE provides assistance on a range of topics including equipment training, capacity building, project feasibility services and decision-support.

First-loss provisions A first-loss provision is a structure designed to protect investors from a loss of the capital that is exposed first if there is a financial loss of security. Development banks may invest first-loss capital into a project or fund to help shield investors from a defined initial amount of losses, thereby reducing risk, improving the credit

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profile of the investment and unlocking private capital to support further lending and investment. One example of a first-loss provision being used in conjunction with other structures is the Global Energy Efficiency and Renewable Energy Fund (GEEREF), a fund of funds established by the European Commission in 2008. It includes a first-loss provision financed by the original funders (the EU, Germany and Norway) to attract private sector investment by reducing the investment risk for such investors.

CASE STUDY Global Energy Efficiency and Renewable Energy Fund (GEEREF)35 Nobody else has done anything like this in the world – a ground-breaking fund attracts private investment for climate and development projects. A few years ago, Alastair Vere Nicoll trekked across Antarctica, recreating the adventure of pioneering polar explorer Roald Amundsen. Now he’s standing on a spot considerably hotter than those icy southern wastes, and he’s part of a project that’s as ground-breaking as the great Norwegian’s journey to the South Pole. Beneath his feet, 250 kilometres south of Addis Ababa, is the Corbetti volcanic caldera, part of the Ethiopian Rift. A happy coincidence of geological features sends water through subterranean fissures in the earth where, heated by the volcanic activity around it, the water turns naturally into steam. Vere Nicoll and his colleagues aim to harness the power of that steam to create electricity. ‘It’s a coalfired power station without the coal,’ he says. In the dustbowl over the caldera, the renewable energy investment company, Berkeley Energy, which Vere Nicoll co-founded, is building Ethiopia’s first independent power project. The pilot stage will be completed in the next two years. Within eight years, Vere Nicoll expects the Corbetti plant to have a capacity of 500 megawatts. That’s approximately a quarter of the country’s total electricity usage and enough to supply 10 million Ethiopians. ‘We’ve done ground-breaking deals in various emerging markets, but this is the most significant project any of us involved will ever work on,’ he says. ‘Really, in our entire careers.’ Vere Nicoll’s cutting-edge project is typical of the work of one of his main investors, the Global Energy Efficiency and Renewable Energy Fund (GEEREF). The fund started with a big chunk of public money which it used to entice private investors. The private money followed, as GEEREF managers hoped it would – even though they planned to invest in projects that typically are seen as risky. A cushion against risk Using the public funds to give private investors a cushion against risk, GEEREF has built a unique portfolio of renewable energy investments in developing countries.

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It has been so successful that GEEREF managers will soon be launching a second, bigger fund. ‘Nobody else has done anything like this in the world,’ says Christopher Knowles, head of the climate change and environment division at the European Investment Bank, which advises GEEREF. The Fund started in 2008 with €112 million in public funds from Norway, Germany and the European Union. In turn, the Fund raised €110 million in private investment. GEEREF’s targets are ambitious: ●●

create 1 gigawatt of clean energy capacity

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save 2 million tons of carbon dioxide

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support energy for 2 million people

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support renewable energy without betting the house

The key to GEEFEFs structure is what’s called a ‘first-loss piece’. That means the public money in the fund is used as a buffer to protect the private investors. If the fund has a loss, it comes out of the public money first. That makes private investors more secure and encourages them to invest in a fund that might otherwise have seemed too risky. Garrie Lette, who runs a €4.5 billion pension fund portfolio in Melbourne, Australia, invested €42 million with GEEREF. Lette acknowledges that renewable energy in a developing country with first-time fund managers ‘doesn’t tick all the boxes for us’. It was GEEREF’s structure that attracted him. ‘We’re driven by risk and return. The presence of the first-loss capital was crucial in our decision to get involved.’ Leveraging public money with private GEEREF drew essentially the same amount of private investment as its public funding. But once that money is invested, it creates further leverage. For every euro GEEREF puts into a project, more than 50 ends up being invested. ‘That’s amazing leverage,’ says Mónica Arévalo Calsina, GEEREF’s senior investment officer. ‘By mitigating the risk of the private sector, we bring much, much greater investment levels.’ That leverage is at work for a series of funds in the GEEREF portfolio: ●●

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Evolution One – $90 million, renewable energy, energy efficiency, environmental projects and companies in southern Africa, based in Cape Town. Renewable Energy Asia Fund – €86 million, renewable energy in India and the Philippines, based in Singapore and managed by Vere Nicoll’s Berkeley Energy. Frontier – €60 million, renewable energy in Sub-Saharan Africa, based in Nairobi and Copenhagen. Emerging Energy Latin American Fund II – $40 million, renewable energy infrastructure, energy service companies in Latin America and the Caribbean, based in Rio de Janeiro and Stamford, Connecticut.

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Armstrong – $164 million, small-scale renewable energy generation and resource efficiency projects in southeast Asia, based in Singapore. MGM Sustainable Energy Fund – $50 million, energy efficiency and renewable energy projects in Central America and the Caribbean, based in Miami. ­ frica Renewable Energy Fund – $200 million, sub-Saharan Africa renewable A energy projects, based in Nairobi, the fund behind the Corbetti project. SolarArise – $100 million, solar photovoltaic projects in India, based in Gurgaon, in the north Indian state of Haryana. Caucasus Clean Energy – $100 million targeted, small hydro projects in Georgia, based in Tbilisi and Singapore.

Now that GEEREF has built up a track record for its strategy, the fund is poised for another round of financing. The plan is for GEEREF II to be considerably bigger, and for private capital to make up a larger proportion of the fund. ‘We expect investors to come back with much more than they did in our first round of financing,’ says GEEREF senior investment officer Gunter Fischer. ‘The first-loss piece will be smaller proportionately than it was in the initial financing round. We’re still mitigating the risk for the private investor, but now we don’t need to offer them as much protection because they can see our track record. We’ve built a lot of trust.’

Grants Grants can be used to cover the costs of specific parts of a project, reducing the overall cost in a transparent manner. Grants can be used upfront to accelerate projects, giving them a kick-start, as a means of reducing the cost of the project over its lifetime and, especially in the case of green and sustainable finance, of supporting the development, prototyping and proof of concept of new technologies or approaches that foster climate change mitigation and adaptation objectives. For this latter reason in particular, grants can be key in pilot projects where the associated risks are very high and the returns uncertain. In 2021, MDBs led by the World Bank established a new facility to provide up to $250  million in grant financing to help countries and others establish net zero targets and develop long-term emissions reduction and climate resilient development strategies. Combining grants with additional support (such as loans and equity) is common – with grant funding (usually) comprising a small proportion of the overall finance required but being deployed at an early stage to unlock later-stage funding. Alternatively, grants may be used to support particular activities as part of a wider project or programme where those activities by themselves might not attract investment finance.

Central and development banks

Equity investment Development banks also help stimulate and catalyse private capital into green and sustainable projects and activities by making equity investments. This can be in the form of early-stage risk capital in firms working on innovative climate and environmental solutions or undertaking research and development into new green and sustainable technologies. As development banks often employ significant in-house technical expertise, equity investments can act as a hallmark of quality that helps crowd in further private sector capital. Thus, development banks can play an important role as ‘investor of first resort’ in emerging sectors or firms. Equity investment, however, usually comprises a relatively small proportion of the total financing provided by development banks. The Joint Report on Multilateral Development Banks’ Climate Finance estimated that total equity investment by MDBs was approximately $1.5 billion in 2019, compared with nearly $45 billion of debt finance.36 This reflects the higher risk profile of early-stage equity investments. Development banks also make strategic investments in externally managed equity funds that have an environmental focus. For example, the European Investment Bank has invested in and works with a number of green infrastructure funds (such as GEEREF, highlighted in the case study above) as well as more bespoke funds focused on issues such as soil decontamination and sustainable agriculture. Some development banks set up their own equity investment funds with the aim of attracting private sector co-investment. One prominent example is the UK Green Investment Bank’s Offshore Wind Fund, described above.

Technical assistance and capacity building Technical assistance and other advisory services are frequently provided by development banks and their partners as part of a package of investment that can help improve project preparation, planning and management, as well as improve the prospect of achieving the desired project outcomes. The provision of assistance and expertise can strengthen the economic and technical foundations of a potential investment and help catalyse funding from the private sector. Furthermore, it can help build expertise and know-how that can be used to support future projects designed to promote climate change mitigation and adaptation. In addition, providing specific technical assistance and building capacity and capability in sustainable finance more generally can help establish an enabling environment for complex projects, promote market awareness among customers and support the successful development of future projects. Technical assistance facilitates knowledge sharing and dissemination of experience and good practice, but care needs to be taken to ensure that there is a real transfer of knowledge and experience to local professionals that enhances the capacity and capability of national capital markets and institutions in respect of green and sustainable finance – not merely a demonstration effect that has no lasting impact.

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CASE STUDY EBRD financing and technical support – Egypt37 Small and medium-sized enterprises (SMEs) in Egypt will benefit from a $100 million loan by the European Bank for Reconstruction and Development (EBRD) to the National Bank of Egypt (NBE) to support energy efficiency, climate change mitigation and the introduction of adaptation technologies. NBE is the largest commercial bank in Egypt. The NBE will on-lend the funds to SMEs in industry, commerce and agriculture to help improve the use of energy, water and land resources, and to make investments in high-performing technologies, to support the Egyptian economy. Businesses can identify green technologies available in Egypt through the Green Economy Financing Facility (GEFF) Technology Selector; they include power generation, cooling, transport, lighting, water use and recovery, and land preparation and seeding.

Key concepts In this chapter, we considered: ●●

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the role of central and development banks (multilateral and national) in relation to green and sustainable finance; how central banks can support the transition to a low-carbon economy through their monetary policy and other banking operations; how development banks play a key role in promoting sustainable economic development and unlocking private finance, and the key products and services they provide; and examples and case studies of central and development banks supporting green and sustainable finance.

Review Central banks are public institutions that oversee the financial system and monetary regime of a country. In most developed countries, central banks are institutionally independent from the government. Since the 2007/08 global financial crisis, and more recently in response to Covid-19, central banks have played a more interventionist role in the economy to achieve monetary policy and financial stability goals. In recent

Central and development banks

years, a number of central banks have received revised mandates that incorporate environmental sustainability alongside traditional economic and financial stability objectives. With responsibility for overseeing and regulating the creation and allocation of money and credit, central banks can significantly impact the greening of the financial system by incentivizing or directing capital away from traditional carbon-intensive sectors towards green and sustainable investment. Several central banks are now taking action to begin to decarbonize their asset purchases and monetary policy operations through revising eligibility and collateral rules to promote the purchase of green and other environmentally sustainable bonds. Central banks have also recalibrated traditional central banking tools with a green and sustainable focus, and in some cases have created new instruments to promote green and sustainable finance. These include credit allocation policy instruments, risk weightings, research and advocacy, and the development of guidelines and frameworks. Central banks can also lead by example by, for instance, publishing their own climate-related financial risk disclosures. With responsibility for overseeing financial stability, and in many cases as financial regulators and supervisors, central banks also have an important impact on the way in which commercial banks and financial institutions respond to the physical and transition risks associated with climate change. Through global bodies such as the Financial Stability Board (FSB) and the Network for Greening the Financial System (NGFS), central banks and other financial regulators coordinate their efforts to manage the impacts of climate change on the financial system. The FSB established a Task Force on Climate-Related Financial Disclosures (TCFD), and central banks have helped set up and support a wide variety of market frameworks, standards and emerging guidance for addressing climate and environmental risks and supporting the growth of green and sustainable finance. Development banks are public (or part-public) financial institutions tasked with promoting socio-economic development in a country or region. They provide finance and a range of advisory and capacity-building programmes to clients whose financial needs are not sufficiently served by private commercial banks or local capital markets, and also deploy these to ‘unlock’ private lending and investment. Whilst most development banks aim to make a profit, their overarching mandate is typically not to maximize returns but to promote a wider range of economic, social and environmental goals. This enables development banks to take a longer-term perspective than private sector institutions, and to assume higher risks, such as working in developing markets and supporting new technologies. This makes them important actors in the green and sustainable finance sector, both through deploying their own capital and through co-financing with the private sector, often referred to as blended finance.

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Multinational Development Banks (MDBs) have played key roles in establishing and developing green and sustainable finance; for example, they issued the first green bonds and have pioneered other financial instruments designed to promote sustainability. Whilst MDBs play a key role in mobilizing sustainable finance, they are supported by and often work with National Development Banks (NDBs), some with mandates to finance and co-finance investment in climate change mitigation and adaptation projects and activities, both in their domestic markets and in developing countries. In recent years, dedicated Green Development Banks (GDBs) have been created to provide financing for green and sustainable projects. They work alongside existing development banks, but have a more specialized mandate. GDBs are still small, however, compared with the larger and more established MDBs and NDBs. Green and sustainable development banking products and services include concessionary loans, bespoke loan products, guarantees, first-loss provisions, grants, equity and venture capital investment, technical assistance and capacity building. Many development banks combine instruments that support projects in both the pre-investment stage (grants and technical assistance) and the investment stage (risk enhancements, funding subsidies and other financial tools) to unlock private lending and investment alongside public sector funding. Table 8.1  Key terms Term

Definition

Blended finance

Using public finance (usually from a development bank, or similar) to unlock additional private sector capital.

Central bank

A public institution that oversees the financial system and monetary policy of a country.

Credit allocation policy

A tool used by a central bank to direct the creation and allocation of credit towards certain industries or sectors.

Development bank

A public (or part-public) financial institution tasked with promoting socio-economic development in a country or region.

Financial Stability Board The FSB, comprising central banks, public international (FSB) financial institutions and international standard-setting organizations, aims to strengthen financial systems and promote international financial stability by coordinating the development of strong regulatory, supervisory and other financial sector policies, and by encouraging consistency in the implementation of these. The FSB established the Task Force on Climate-Related Financial Disclosures (TCFD) in 2015. Green development banks

National or sub-national banks whose purpose is to provide financing for green and sustainable projects. Sometimes simply referred to as ‘green banks’. (continued)

Central and development banks

Table 8.1  (Continued) Term

Definition

Green supporting factor Reduces the amount of capital a bank needs to hold in reserve, facilitating the allocation of more capital and greater lending amounts to green and sustainable projects. Macroprudential policy

Policy aimed at preventing an excessive build-up of systemic risk in the financial system resulting from factors such as asset price bubbles or excessive risk-taking by banks.

Microprudential regulation

Supervision of individual financial institutions to ensure that they are resilient and solvent.

Multilateral Development Banks (MDBs)

Supranational institutions established by sovereign states, with aims and objectives reflecting the development and cooperation policies of their sovereign shareholders. MDBs have played key roles in establishing and developing the green and sustainable finance sector.

Patient capital

Capital invested for the long term, usually more than 10 years. Patient capital is often, but not necessarily, deployed mainly by MDBs and other public sector financial institutions more easily able to take a long-term perspective.

Quantitative easing

An unconventional form of monetary policy where a central bank creates new money electronically to buy financial assets, such as government bonds, in order to directly increase private sector spending in the economy and return inflation to target.

Stress testing

Assessments conducted (or ordered) by central banks to model the resilience of the financial sector overall, and/or that of individual financial institutions, to shocks and scenarios.

Notes 1 Dikau, S and Volz, U (2020) Central Bank mandates, sustainability objectives and the promotion of green finance, London, SOAS Department of Economics Working Paper No. 232, https://www.soas.ac.uk/economics/research/workingpapers/file145514.pdf 2 Governor of the Bank of England (2021) Remit and recommendations for the Financial Body Policy Committee, https://assets.publishing.service.gov.uk/government/uploads/ system/uploads/attachment_data/file/965778/FPC_Remit_and_Recommendations_ Letter_2021.pdf (archived at https://perma.cc/27BH-LRPP) 3 Cuff, M (2017) Printing money, burning carbon? Why QE may be stimulating more than just the money markets, Business Green, https://www.businessgreen.com/ analysis/3010873/printing-money-burning-carbon-why-qe-may-be-stimulating-more-thanjust-the-money-markets (archived at https://perma.cc/SZA9-CH6V)

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Green and Sustainable Finance 4 Caswell, G (2021) PBOC plans green credit facility, Green Central Banking, https:// greencentralbanking.com/2021/08/04/pboc-plans-green-credit-facility/ (archived at https://perma.cc/DD72-CW8X) 5 Bank of Japan (2021) Monetary Policy, https://www.boj.or.jp/en/mopo/measures/mkt_ ope/ope_x/opetori22.htm/ (archived at https://perma.cc/BK6S-5FHG) ­6 Dikau, S and Ryan-Collins, J (2017) Green central banking in emerging market and developing country economies, New Economics Foundation, https://neweconomics.org/ uploads/files/Green-Central-Banking.pdf (archived at https://perma.cc/5HX2-9VBZ) 7 Central Bank of Malaysia (2021) Governor’s Keynote Address at the JC3 Flagship Conference, https://www.bnm.gov.my/-/governor-keynote-jc3-flagship-conference (archived at https://perma.cc/5P9H-QJQB) 8 Bank of England: Prudential Regulation Authority (2021) Climate-related financial risk management and the role of capital requirements, https://www.bankofengland. co.uk/-/media/boe/files/prudential-regulation/publication/2021/october/climate-changeadaptation-report-2021.pdf?la=en&hash=FF4A0C618471462E10BC704D4AA58727E C8F8720 (archived at https://perma.cc/75G3-RFCP) 9 Centre for Climate Change Economics and Policy (2017) Green doesn’t mean risk-free: why we should be cautious about a green supporting factor in the EU, https://www. cccep.ac.uk/news/eu-green-supporting-factor-bank-risk/ (archived at https://perma.cc/ QR9D-2C7P) 10 European Central Bank (2020) Guide on Climate-related and Environmental Risks: Supervisory expectations relating to risk management and disclosure, https://www.bank​ ingsupervision.europa.eu/ecb/pub/pdf/ssm.202011finalguideonclimate-relatedandenviro​ nmentalrisks~58213f6564.en.pdf?1f98c498cb869019ab89194a118b9db4 (archived at https://perma.cc/R5FL-4RXE) 11 European Banking Authority (2021) EBA Publishes its Report on Management and Supervision of ESG risks for credit institutions and investments firms, https://www.eba. europa.eu/eba-publishes-its-report-management-and-supervision-esg-risks-credit-institu​ tions-and-investment (archived at https://perma.cc/NQH5-XN4W) 12 Bank of England (2021) Guidance for Participants of the 2021 Biennial Exploratory Scenario: Financial risks from climate change, https://www.bankofengland.co.uk/-/media/ boe/files/stress-testing/2021/the-2021-biennial-exploratory-scenario-on-the-financialrisks-from-climate-change.pdf?la=en&hash=2E5CAECE75E701315B51B09303F99FCF 8D21C8E2 (archived at https://perma.cc/M4H9-H7LY) 13 UNEP (2017) Establishing China’s Green Financial System, https://www.unepfi.org/ fileadmin/communications/EstablishingChinasGreenFinancialSystem.pdf (archived at https://perma.cc/9Y5J-ACD8) and author’s own research 14 NGFS (2021) Guide on Climate-related Disclosure for Central Banks, https://www.ngfs. net/sites/default/files/medias/documents/guide_on_climate-related_disclosure_for_central_ banks.pdf (archived at https://perma.cc/8VBF-TZ2P) 15 Barmes, D and Livingstone, Z (2021) The Green Central Banking Scorecard: How green are G20 central banks and financial supervisors? http://positivemoney.org/ wp-content/uploads/2021/03/Positive-Money-Green-Central-Banking-Scorecard-Report31-Mar-2021-Single-Pages.pdf (archived at https://perma.cc/88NC-CP46)

Central and development banks 16 De Luna-Martinez, J and Leonardo Vicente, C (2012) Global Survey of Development Banks: Policy Research Working Paper 5969, http://documents.worldbank.org/curated/ en/313731468154461012/pdf/WPS5969.pdf (archived at https://perma.cc/EK5W-BQLA) 17 European Investment Bank (2020) EIB Group: Climate Bank Roadmap 2021–2025, https://www.eib.org/attachments/thematic/eib_group_climate_bank_roadmap_en.pdf (archived at https://perma.cc/3DUP-HKZJ) 18 European Bank for Reconstruction and Development (nd) Green Economy Transition: What is the EBRD’s Green Economy Transition Approach? https://www.ebrd.com/whatwe-do/get.html (archived at https://perma.cc/HV2F-CJRB) 19 Asian Development Bank (2018) Strategy 2030: Achieving a prosperous, inclusive, resilient and sustainable Asia and the Pacific, https://www.adb.org/documents/strategy2030-prosperous-inclusive-resilient-sustainable-asia-pacific (archived at https://perma. cc/77NG-76UV) 20 African Development Group (2022) Climate Change, https://www.afdb.org/en/topicsand-sectors/sectors/climate-change (archived at https://perma.cc/KM8B-8GDN) 21 Inter-American Development Bank (2022) Environment and Natural Disasters, https://www.iadb.org/en/sector/climate-change/overview (archived at https://perma. cc/8ZTV-65TV) 22 The World Bank (2021) What you need to know about the World Bank Group’s 2nd Climate Change Action Plan, https://www.worldbank.org/en/news/feature/2021/06/22/ what-you-need-to-know-about-the-world-bank-group-2nd-climate-change-action-plan (archived at https://perma.cc/KSD7-RZ6K) 23 Studart, R and Gallagher, K (2016) Infrastructure for Sustainable Development: The role of national development banks, https://www.bu.edu/pardeeschool/files/2016/08/ Infrastructure.Sustainable.Final_.pdf (archived at https://perma.cc/E5HS-DCP9) 24 Griffith-Jones, S, Attridge, S and Gouett, M (2020) Securing Climate Finance Through National Development Banks, https://cdn.odi.org/media/documents/200124_ndbs_web. pdf (archived at https://perma.cc/QHK3-ELKT) 25 KFW (nd) Climate Change: Combating Climate Change with KFW, https://www.kfw. de/nachhaltigkeit/KfW-Group/Sustainability/Unser-Anspruch/Finanzierung-Förderung/ Klimawandel/ (archived at https://perma.cc/3GSM-P5YK) 26 The Scottish National Investment Bank (2022) The Bank’s Missions, https://www. thebank.scot/about/our-missions/ (archived at https://perma.cc/SPT9-JTYP) 27 Shah, A (2015) Development banking for sustainability, Devex, https://www.devex. com/news/development-banking-for-sustainability-87333 (archived at https://perma.cc/ ZS5K-QNCU) 28 Bodnar, P et al (2020) State of Green Banks 2020, Rocky Mountain Institute, https://rmi. org/insight/state-of-green-banks/ (archived at https://perma.cc/8L9A-LTCX) 29 Green Investment Group (2017) World’s first offshore wind fund manager powers through £1bn target, https://greeninvestmentgroup.com/news-and-insights/2017/world-sfirst-offshore-wind-fund-manager-powers-through-1bn-target/ (archived at https://perma. cc/HY2U-8PZ2)

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Green and Sustainable Finance 30 EBRD (2019) Joint Report on Multilateral Development Banks’ Climate Finance, https:// www.eib.org/attachments/press/1257-joint-report-on-mdbs-climate-finance-2019.pdf (archived at https://perma.cc/W6BR-7S79) 31 BloombergNEF (2019) The Clean Technology Fund and Concessional Finance: Lessons learned and strategies moving forward, https://data.bloomberglp.com/professional/ sites/24/BNEF_The-Clean-Technology-Fund-and-Concessional-Finance-2019-Report.pdf (archived at https://perma.cc/DH9D-LZRS) 32 Development Bank of Japan (2022) DBJ Sustainability Linked Loans with Engagement Dialogue, https://www.dbj.jp/en/service/program/interactive/ (archived at https://perma. cc/FGY6-EZ3U) 33 Pothig, C (2018) KfW’s significant contribution to the energy transition: 47% of ­renewable generating capacity installed in Germany in 2015/16 financed by KFW, https://www.kfw.de/KfW-Group/Newsroom/Latest-News/PressemitteilungenDetails_455616.html (archived at https://perma.cc/P42B-3H7T); KfW Group (2016) Sustainability Report: Facts and figures update 2016, https://www.kfw.de/ PDF/Download-Center/Konzernthemen/Nachhaltigkeit/englisch/Facts-and-FiguresUpdate-2016.pdf (archived at https://perma.cc/F2V5-KBX8) 34 Originally published by the Center for Clean Air Policy (2010) as Expanding Access to Energy Efficiency Finance Through the Use of Credit Guarantees, China, https://studylib. net/doc/18839627/china-expanding-access-to-energy-efficiency-finance-through (archived at https://perma.cc/TA76-3DA9) 35 Adapted from European Investment Bank (2016) Climate and development: ‘Nobody else has done anything like this in the world’, https://www.eib.org/en/stories/climate-anddevelopment-equity (archived at https://perma.cc/C2C8-QESX) 36 EIB (2019) Joint Report on Multilateral Development Banks’ Climate Finance, https:// www.eib.org/attachments/press/1257-joint-report-on-mdbs-climate-finance-2019.pdf (archived at https://perma.cc/W6BR-7S79) 37 European Bank for Reconstruction and Development (2021) EBRD and NBE support small businesses in Egypt, https://www.ebrd.com/news/2021/ebrd-and-nbe-support-smallbusinesses-in-egypt.html (archived at https://perma.cc/EB9C-PM5D)

9

­ esponsible and R sustainable investment Introduction Investors – retail and institutional investors in public and private markets – play a key role in allocating capital. To ensure a successful global transition to net zero, and to enhance climate-resilient development, it is vital that investors decarbonize portfolios and investment flows to key sectors such as renewable energy and ‘green’ building and transport. In addition, as we have seen in earlier chapters, investment also needs to support sectors and firms as they transition from high-carbon to more sustainable business models. Investment managers are an essential bridge between savers and businesses seeking finance; how they – and you – invest matters. There has been substantial growth in sustainable investing in recent years, as the climate crisis, climate risk and investment opportunities from the transition to a sustainable, low-carbon world have come into focus for all types of investors. Rapid growth increases the risk of greenwashing, however, and creates other challenges for investors, investment managers and regulators.

L E A R N I N G OB J ECTI VES On completion of this chapter, you will be able to: ●●

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Understand the role of investment within the wider financial system, and how investment impacts and is impacted by environmental and social sustainability factors. ­ escribe different investment approaches and products, their suitability for D different types of investors and how they may support green and sustainable finance.

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Describe the growth in responsible and sustainable investment, and the reasons for this. Explain the differences and similarities between responsible and sustainable investing, ESG, impact investing and other related terms. Describe different types of investment funds and explain how these may support investment in green and sustainable finance. Discuss the risks of greenwashing and other challenges to the growth of responsible and sustainable investing.

Introduction to investment Foundations of investment Before exploring sustainable investment, it is worth considering in brief the foundations of investing and investment management in general. The traditional approach to investment, applicable to both retail investors (non-professional individuals investing their savings) and institutional investors (professional investors investing on their own behalf, and/or pooling funds from many individuals or entities and investing on their behalf) bases investment decision making on: ●●

investors’ financial goals (e.g. ‘preserve capital’, ‘generate annual income’, ‘capital growth’);

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investors’ time horizons (e.g. short-term versus saving for retirement); and

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the level of risk investors are willing to take (e.g. low versus high risk appetite).

A basic principle of investing is the risk/reward trade-off. That is, the greater the risk, the greater the potential reward for an investor, as set out in Figure 9.1.

QUICK QUESTION How might the risks and opportunities from climate change impact investors’ risk/ return trade-offs?

As we will see in this chapter, as investors’ understanding of climate change and the physical and transition risks of climate change (which we covered in detail in Chapter 5) have developed, this has altered the risk/return profile for many. In addition, for investors with longer time horizons, the mid-century net zero commitments

Responsible and sustainable investment

Figure 9.1  Risk/reward trade-off Equity

High return

Alternative investments Debt

Real estate and tangible assets

Money market and cash equivalents Low return Low risk

High risk

made by many countries and organizations are also impacting on the longer-term risk/return trade-off. The prospects of increased costs, significantly reduced demand, litigation risks and stranded assets increases the risks and decreases the likely returns from investments in high-carbon sectors and firms. Conversely, the opportunities from the transition to a sustainable, low-carbon world become more attractive to investors as the risks go down (as new technologies are proven, and the direction of regulation and policy becomes more certain) and the potential rewards go up. There are sound reasons, therefore, to invest in low-carbon assets (and divest from high-carbon assets) on purely risk/reward grounds, and this lies behind much of the recent growth in sustainable investment, as we will examine later in this chapter. As we will also explore, many investors also seek to achieve environmental or other sustainability returns alongside financial returns (often referred to as ‘impact investing’ and/or ‘values-based investing’). This is another factor driving the growth of the sustainable investment sector.

Asset classes Individuals and institutions can invest in a very wide range of assets, which may be classified in a variety of different ways. For our purposes, we identify five main investment asset classes, some of which we have already covered in previous chapters. These are: ●●

Equity: Owning a share (stock) of a company and partaking in any profits. Investors may purchase shares in a company directly, or through funds and other investment vehicles usually managed by professional investment managers.

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Debt (‘fixed income’): Lending money to a company, government or other organization and collecting interest. We looked at different types of green and sustainable loans and bonds, and green bond indices and funds, in Chapter 7. Money market and cash equivalents: Holding cash across different currencies, or investments that are highly liquid and can be sold and converted to cash almost instantly. Real estate: Buying property, or investing in real estate funds that invest in residential and commercial property (as we have seen in earlier chapters, the construction and operation of buildings is a major source of greenhouse gas emissions). Alternative investments: Investments that do not fall into any of the above categories, e.g. angel investing and venture capital, commodities, collectibles such as art, vintage cars, wine and cryptocurrencies (which we examine in Chapter 11).

­ etail and institutional investors often blend some or all of these different asset R classes together to create an investment portfolio with a risk/return profile that suits their needs and preferences. In this chapter, we focus mainly on equity investment, but similar principles of green finance and sustainable investment can be applied to other asset classes, too.

QUICK QUESTION Thinking of your personal savings and investments, which of the above asset classes do you hold? Have you considered environmental and other sustainability issues when making your investment decisions?

Introduction to responsible and sustainable investment Definitions of sustainable investment In the context of green and sustainable finance, a wide variety of terms including ‘ESG investment’, ‘ethical investment’, ‘impact investment’, ‘responsible investment’, ‘SRI investment’ and ‘values-based investing’ are in common use. All describe investments and/or investment approaches and strategies designed to deliver and support positive environmental and social impacts (and/or avoid negative impacts) as well as – usually – financial returns. Although the above terms are often used interchangeably, there can be important differences between them, which we explore below. For the purposes of this book, we will usually refer to sustainable investment/sustainable investing except where the context requires the use of a

Responsible and sustainable investment

different term. We generally use these terms to refer to an approach to investing and investment decision making that involves selecting investments that deliver positive environmental and social benefits and support the transition to an environmentally and socially sustainable, low-carbon world, combined with reducing or eliminating investments in harmful sectors and firms. The aim is to generate financial returns by reducing climate, environmental and other sustainability risks and taking advantage of the opportunities from the transition to net zero, as well as delivering positive impacts for the environment and/or society. This focus on impact – both in terms of investing for positive impact, and minimizing negatives impacts – is key. Another term often used to encompass sustainable investment and related terms is values-based investing – that is, activities and strategies that take into account investors’ beliefs, preferences and values, including environmental, ethical, social and other factors, alongside their desire for a financial return. This approach to investing (and ‘ethical investment’, defined below) is not new; it dates back to at least the 1700s, when groups such as the Quakers established guidelines for banking and investment based on religious and philosophical principles. An Environmental, Social and Governance (ESG) approach is intended to integrate these three factors into traditional financial analysis of investments. One or more ESG factors may increase the risk profile of an investment (for example, if assets are exposed to substantial climate risks) or the potential returns on offer (for example, if a company has developed a new, emissions-reducing technology). There is no single method for assessing ESG factors, or for labelling an investment or fund as ‘ESG’, as we shall see in this chapter, but in general they will encompass one or more of the following factors: ●●

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Environmental factors: Energy use (and mix of renewable/non-renewable energy), emissions, waste production, impact on the natural environment. Social factors: Human rights, equality, engagement with and impact on communities, employee relations. Governance factors: Quality of board and senior management, shareholder rights, transparency and disclosure.

At the present time there tends to be a strong focus by many investors on the ‘E’ (environmental factors), especially climate-related risks and opportunities. As we have explored elsewhere in this book, though, ‘S’ (social) and ‘G’ (governance) factors are often interlinked with these. ESG is generally seen as a ‘positive screening’ or ‘inclusive screening’ approach to investing (see below), as – usually – investments will be identified that exhibit favourable ESG factors such as those set out above. Some investment managers and funds use ‘negative screening’ to exclude some sectors such as gambling, pornography, alcohol and weaponry. As we set out in Chapter 1, ESG approaches tend to

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focus on how organizations incorporate these three factors. A broader sustainability/ sustainable finance approach also needs to consider the economic, environmental and societal impacts – both positive and negative – of an organization’s activities, operations, and lending and investment decisions. Whilst many use the terms ‘ESG’ and ‘sustainable’ interchangeably, this difference is important, for it is the impacts we need to understand and measure when monitoring progress towards a more sustainable, low-carbon world. A common criticism of the ESG approach is that there can sometimes be more focus on the ‘G’ (governance) than the ‘E’ (environmental) and/or the ‘S’ (social). This can lead to the seemingly perverse inclusion of major greenhouse gas emitters (for example, airport operators) in ESG indices and funds because they score very highly in terms of governance – the lack of a common, agreed methodology for calculating ESG scores and ratings is a significant concern for investors, regulators and others. The development of taxonomies, and related regulatory interventions (e.g. the development of fund labelling schemes linked to taxonomies) should help bring greater clarity, consistency and comparability over time. Ethical investment is a catch-all term generally used to describe investments, or investment approaches and strategies, based on investors’ or investment managers’ ethical and philosophical beliefs. Whilst this may include ESG and other forms of investment, and retail investment funds can often be labelled as ‘ethical’ to avoid confusing potential customers with jargon, the term is better used to refer to investment grounded in religious or other philosophical beliefs. This often involves the exclusion of certain sectors (‘negative screening’) such as alcohol, tobacco and weapons, sometimes referred to as ‘sin stocks’; depending on the ethical beliefs involved, other sectors may be excluded, too. The Islamic investment platform Simply Ethical excludes investment in conventional financial services, for example, because charging and receiving interest is not permitted on religious grounds.1 As with ESG labelling above, there is no common, agreed definition or methodology for describing an investment or fund as ‘ethical’. Moreover, there is little prospect of this changing, as there are no plans for the development of ‘ethical taxonomies’ or the like; however, general regulations relating to the avoidance of mis-selling would usually apply to the use of the term ‘ethical’.

QUICK QUESTION How do your own ethical and philosophical beliefs impact your own choice of investments (and products and services more broadly)? Are there any sectors or companies you avoid – or champion – on ethical grounds?

Responsible and sustainable investment

The term responsible investment was first adopted by students in North America and elsewhere in the 1960s and 1970s, in protest against universities investing their endowments and pension funds in apartheid-era South Africa. Today, the term is more commonly used to describe an approach to investment decision making informed by and aligned with the UN Principles for Responsible Investment, introduced in earlier chapters – an active approach to incorporating ESG factors into investment decision making, strategies and engagement with investors and investees, with a focus on impacts. It may be thought of as broadly synonymous with ‘sustainable investment’.

THE UN PRINCIPLES FOR RESPONSIBLE INVESTMENT 2 The United Nations Environment Programme (UNEP) Finance Initiative and the United Nations Global Compact established the Principles for Responsible Investment (PRI) in 2006, with the goal of working with investors to support a more sustainable global financial system. As of December 2021, the Principles have some 4,600 signatories representing more than $120 trillion in assets under management (AUM). The Principles are voluntary and aspirational, offering a ‘menu’ of possible actions for incorporating environmental, social and governance (ESG) factors into investment analysis and decision making. Signatories to the Principles publicly commit to adopting and implementing them ‘where consistent with their fiduciary responsibilities’. Principles for Responsible Investment 1. We will incorporate ESG issues into investment analysis and decision-making processes Possible actions: ●●

Address ESG issues in investment Policy statements.

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Support the development of ESG-related tools, metrics and analyses.

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Assess the capabilities of internal investment managers to incorporate ESG issues. Assess the capabilities of external investment managers to incorporate ESG issues. Ask investment service providers (such as financial analysts, consultants, brokers, research firms or rating companies) to integrate ESG factors into evolving research and analysis.

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Encourage academic and other research on this theme.

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Advocate ESG training for investment professionals.

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2. We will be active owners and incorporate ESG issues into our ownership policies and practices Possible actions: ●●

Develop and disclose an active ownership policy consistent with the Principles

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Exercise voting rights or monitor compliance with voting policy (if outsourced).

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Develop an engagement capability (either directly or through outsourcing).

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Participate in the development of policy, regulation and standard setting (such as promoting and protecting shareholder rights).

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File shareholder resolutions consistent with long-term ESG considerations.

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Engage with companies on ESG issues.

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Participate in collaborative engagement initiatives.

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Ask investment managers to undertake and report on ESG-related engagement.

3. We will seek appropriate disclosure on ESG issues by the entities in which we invest Possible actions: ●●

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Ask for standardized reporting on ESG issues (using tools such as the Global Reporting Initiative). Ask for ESG issues to be integrated within annual financial reports. ­ sk for information from companies regarding the adoption of/adherence to A relevant norms, standards, codes of conduct or international initiatives (such as the UN Global Compact). Support shareholder initiatives and resolutions promoting ESG disclosure.

4. We will promote acceptance and implementation of the Principles within the investment industry Possible actions: ●● ●●

Include Principles-related requirements in requests for proposals (RFPs). Align investment mandates, monitoring procedures, performance indicators and incentive structures accordingly (for example, ensure investment management processes reflect long-term time horizons when appropriate).

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Communicate ESG expectations to investment service providers.

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Revisit relationships with service providers that fail to meet ESG expectations.

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Support the development of tools for benchmarking ESG integration.

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Support regulatory or policy developments that enable implementation of the Principles.

Responsible and sustainable investment

5. We will work together to enhance our effectiveness in implementing the Principles Possible actions: ●●

Support/participate in networks and information platforms to share tools, pool resources, and make use of investor reporting as a source of learning.

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Collectively address relevant emerging issues.

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Develop or support appropriate collaborative initiatives.

6. We will each report on our activities and progress towards implementing the Principles Possible actions: ●●

Disclose how ESG issues are integrated within investment practices.

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Disclose active ownership activities (voting, engagement and/or policy dialogue).

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Disclose what is required from service providers in relation to the Principles.

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Communicate with beneficiaries about ESG issues and the Principles.

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Report on progress and/or achievements relating to the Principles using a ‘Comply or Explain’ approach. ­Seek to determine the impact of the Principles. Make use of reporting to raise awareness among a broader group of stakeholders.

Socially responsible investment (SRI) describes an active approach to investment and investment decision making involving the selection or elimination of investments based on ethical guidelines and SRI ‘screens’ determined by the investor or investment manager, such as alcohol and tobacco, gambling, human rights and environmental impact. It is comparable to ESG in many ways, although it tends to lack emphasis on governance or the ‘ethical investment’ approach described above. Traditionally, SRI approaches were based on ‘negative screening’, that is, the avoidance and exclusion of shares, securities, funds and other assets that conflict with the investor’s beliefs and personal values, where investors were often willing to accept lower returns. More recently, SRI approaches have also adopted positive screening, seeking to identify opportunities for investment, rather than investments to avoid. The objective of impact investment is to achieve specific (usually) environmental and/or social objectives, although the term could relate to any form of investing where there is a focus on non-financial outcomes alongside financial returns. When in its infancy, impact investment was often conducted on a philanthropic basis, with investors more concerned with environmental and social objectives than financial

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returns. Today, especially in the context of climate-related and environmental-related impact investing, this is often no longer the case. In fact, as alluded to above, in order to meet the objectives of the Paris Agreement and other sustainability goals, all investment that seeks to align itself with these needs to understand and measure environmental and other sustainability impacts, both positive and negative. One of the key characteristics of modern impact investment is that impacts must be measurable. A great deal of work has been done by the Global Impact Investing Network (GINN),3 the Impact Investing Institute4 and others in recent years to develop approaches and methodologies for identifying and measuring environmental and social impacts, some of which we introduced in Chapter 4. GINN defines impact investment as ‘Investments made with the intention to generate measurable social and environmental impact, alongside a financial return’, noting that an impact investment approach is often used to address environmental and social challenges in sectors such as agriculture, conservation, renewable energy and microfinance, and to ensure access to affordable basic services such as education, healthcare and housing.

QUICK QUESTION What are some of the main similarities and differences underpinning the different terms described above?

Sustainable investment strategies: from light to dark green In the preceding section, we described different approaches to what can be described overall as ‘sustainable investment’. We also introduced terms such as ‘negative screening’ and ‘positive screening’, which are used to describe different strategies used by investors and investment managers to select investments. In this section, we introduce a range of strategies that can be used to select investments and construct portfolios that meet sustainable investment criteria determined by investors and investment managers. These are presented on a spectrum from ‘light green’ to ‘dark green’, with the latter representing the most complete and holistic approach to sustainable investment. Adopting dark green strategies can be very time and resource intensive, however, especially for individual investors. Investors and investment managers may also adopt active or passive investment strategies, or a combination of both. These are discussed and contrasted later in this chapter.

a) Very light green: negative screening As we saw above, negative screening refers to the exclusion of certain assets, companies or sectors from an investment portfolio in accordance with pre-defined criteria.

Responsible and sustainable investment

Criteria are set by investors and/or investment managers in line with their ethical and religious beliefs, values, preferences and investment aims, but in the context of sustainable investment negative screening usually means the exclusion of environmentally and socially harmful sectors such as oil and gas, alcohol, gambling and pornography. Negative screening does not necessarily mean that prohibited activities are completely excluded from a fund or portfolio; generally, assets may be included if less than 15 per cent of revenues are generated from the prohibited activity (e.g. a retailer may be included if less than 15 per cent of its overall revenue comes from the sale of alcohol). These are known as ‘materiality thresholds’ or ‘acceptance levels’; they help investors and investment managers build diversified portfolios. Negative screening can (subject to materiality thresholds) ensure that investments avoid harmful sectors and activities, and therefore reduce exposure to climate, environmental and other sustainability risks. They avoid harm rather than seek to achieve positive environmental and social returns. In doing so, however, they may miss opportunities to identify firms, sectors and activities that will benefit from the transition to a more sustainable world, and the financial and impact returns accruing from these.

b) Light green: positive screening The opposite of negative screening, positive screening refers to the inclusion of assets, companies or sectors in an investment portfolio that meet pre-defined criteria determined by investors and/or investment managers. It is often used in conjunction with negative screening, so that – in the context of sustainable investment – portfolios comprise investments that ‘do good’ and avoid investments that would have negative impacts on the environment and society. Materiality thresholds may also be used to help build diversified portfolios, in a manner similar to that described above. By adopting a positive screening approach, investors are more likely to benefit from investments in firms, sectors and activities that will benefit from the transition to a more sustainable world, as they avoid climate, environmental and other sustainability risks. Positive screening criteria vary widely, and may be applied at the sectoral level (for example, via a mandate to invest in renewable energy, clean transport and climate-resilient infrastructure) and/or the asset level. In the context of sustainable investment, ESG ratings and scores or other labels and certifications are often used to determine inclusion on the basis that these signal the positive environmental and/ or social credentials of the investment. The lack of a common, agreed methodology for calculating ESG scores and ratings, however (there are more than 1,000 different ESG scores and ratings available), makes it difficult for investors to compare different potential investments. Furthermore, scores and ratings that overweight governance factors may lead to investment in sectors or firms that damage the environment or society. Following a survey of ESG ratings providers, users and subjects, the International Organization of Securities Commissions (IOSCO) identifies several issues with

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ratings. Given their importance to investors and others, these require consideration. There is/are, in IOSCO’s view: ●●

little clarity and alignment on definitions, including on what ratings are intended to measure;

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a lack of transparency about the methodologies underpinning ratings;

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uneven sectoral and geographical coverage;

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concerns about the management of conflicts of interest where ESG ratings providers also perform consulting services for companies that are the subject of ratings; the need for better communication with companies that are the subject of ESG ratings, given the importance of ensuring these are based on sound information.5

IOSCO recommends that regulators should consider whether the introduction of regulatory oversight might bring greater consistency to ESG ratings. In addition, ESG ratings providers should improve transparency, disclosure and any potential conflicts of interest.

QUICK QUESTION Thinking of your personal savings and investments, do you conduct any informal or formal negative or positive screening? What sectors do you try to avoid and/or invest in?

c) Green: active ESG investing To overcome some of the drawbacks of a positive screening approach relying on ESG scores and ratings, investors and investment managers can adopt a more active investment strategy. This might involve a ‘best in class’ approach, where funds and portfolios are built from assets with only the highest ESG scores and ratings in each sector (e.g. the highest 10 per cent). This may help overcome some of the drawbacks of such scores and ratings described above and filter out less environmentally and socially sustainable activities and firms. In addition, investors and investment managers may supplement ESG scores and ratings with their own (or independent) analysis of potential investments’ environmental and social impacts – both positive and negative. This is costly and time-intensive, however, and is therefore most relevant to large institutional investors with the resources to undertake such analysis.

Responsible and sustainable investment

READING Sustainable Finance Disclosures Regulation – Article 8 v Article 96 In 2023, the European Commission’s Sustainable Finance Disclosures Regulation (SFDR) will come into effect. Part of the Commission’s Sustainable Finance Action Plan, a key aim of the SFDR is to prevent greenwashing by introducing new transparency and disclosure requirements for financial firms providing or advising on investment and mutual funds, UCITS and pensions. The new rules will apply to all firms operating in the EU, and to firms marketing their products, services and advice in the EU. The SFDR introduces three main disclosure requirements for financial providers and advisers: 1 An adverse impact statement, which sets out how a firm considers the negative impacts of investments on 64 environmental and social sustainability indicators (18 are mandatory, 46 are voluntary). 2 A description of how a firm integrates its assessment of sustainability (ESG) risks in its investment strategies and decision-making processes (including how remuneration and incentives are linked to this). 3 A classification of funds into one of three categories (Article 6, 8 or 9), depending on the extent to which sustainability is a consideration. Article 6 funds are those that do not have investment objectives related to sustainability (ESG) factors. Firms and advisers are still required to disclose how sustainability risks are considered, however, as set out above. Article 8 funds are those that seek to promote environmental and/or social sustainability characteristics, although these are not core objectives. Fund managers will tend to follow a positive screening/ESG investing approach, and hence Article 8 funds are referred to as ‘light green’. Article 9 funds have environmental and/or social sustainability factors as core objectives, and are referred to as ‘dark green’ – i.e. they adopt an impact investing approach.

d) Dark green: impact investing As we described above, impact investing requires measurable environmental and/or social returns alongside financial returns, but where such returns can be identified, measured and reported, thereby giving investors greater confidence in the environmental and social performance of investments. Rather than rely on the ESG scores

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and ratings developed by others, impact investors and investment managers seek to identify, understand and measure the environmental and social benefits of their investments. As we discussed in Chapter  4, however, impact measurement can be complex, challenging, time-consuming and resource intensive, and is therefore likely to be undertaken only by specialist and/or large institutional investors. Bodies such as the new International Sustainability Standards Board (ISSB) and, previously, the Carbon Disclosure Standards Board (CDSB) and Carbon Disclosure Project (CDP), seek to standardize the measurement of greenhouse gas emissions, whereas the measurement of social and other sustainability returns is supported by the Impact Reporting and Investment Standards (IRIS) developed by the Global Impact Investment Network (GIIN). This sets out 16 impact categories, aligned with the UN Sustainable Development Goals. The IRIS+ Core Metrics provide consistent and comparable data for assessing the environmental and broader sustainability impacts of investments.7 The Impact Investing Institute has produced a range of useful learning materials for investors and others on impact measurement, management and reporting. As they state, though: ‘Please bear in mind that there is no single good way to measure impact – there are many helpful approaches, processes and frameworks, but no silver bullet. It is important to measure impact well, but almost impossible to measure it perfectly. Aim for good.’8

e) Very dark green: investor engagement and activism Arguably, the deepest green investment strategy is to engage with the boards and senior managers of organizations to seek change. All shareholders are part owners of the firms and other assets they invest in, and can use their rights to influence change by exercising (or threatening to exercise) their voting rights. Shareholders include large asset managers or institutional investors with mandates to engage in active stewardship of the investments in their portfolio(s), or individuals or other entities, such as NGOs, who seek change for environmental or other ethical reasons – often referred to as ‘shareholder activism’. Investors of all types have always sought to influence the strategic direction of the assets and companies they own, but increasingly, engagement includes sustainability considerations; for example, seeking to influence a company’s environmental policies, corporate culture, governance structure, diversity and inclusion or strategy, and leadership overall. This may be driven by a sense of environmental activism, by investors’ desire to encourage companies to better identify and manage climate, environmental and social sustainability risks, by a belief that better returns can be gained by aligning a company’s strategy and activities with sustainability objectives, or by a combination of these.

Responsible and sustainable investment

CASE STUDY Climate Action 100+9 What is Climate Action 100+? Climate Action 100+ is an initiative led by major institutional investors to engage systemically important greenhouse gas emitters and other companies across the global economy that have significant opportunities to drive the clean energy transition and help achieve the goals of the Paris Agreement. Investors actively engage with companies to improve governance on climate change, curb emissions and strengthen climate-related financial disclosures. To date (March 2022), Climate Action 100+ has been joined by 615 institutional investors. The initiative estimates that the nearly 170 major emitters engaged with account for some 80 per cent of total global industrial emissions. Why was Climate Action 100+ formed? In 2015, nearly 200 countries signed the Paris Agreement, which aims to keep the increase in global average temperature to well below 2°C above pre-industrial levels. The investor signatories of Climate Action 100+ believe that engaging and working with the companies in which they invest – to secure greater disclosure of climate change risks and robust company strategies aligned with the Paris Agreement – is consistent with their fiduciary duty, and is essential to achieving the goals of the Paris Agreement. Climate Action 100+ is designed to implement the investor commitment first set out in the Global Investor Statement on Climate Change in the months leading up to the adoption of the Paris Agreement: ‘As institutional investors and consistent with our fiduciary duty to our beneficiaries, we will: . . . work with the companies in which we invest to ensure that they are minimizing and disclosing the risks and maximizing the opportunities presented by climate change and climate policy.’ What are investors asking focus companies to do? Investors signed on to Climate Action 100+ are requesting that boards and senior management of companies: 1 implement a strong governance framework that clearly articulates the board’s accountability and oversight of climate change risks and opportunities; 2 take action to reduce greenhouse gas emissions across the value chain, consistent with the Paris Agreement’s goal of limiting global average temperature increases to well below 2°C above pre-industrial levels; and 3 provide enhanced corporate disclosure in line with the recommendations of the TCFD and other applicable frameworks to enable investors to assess the

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robustness of companies’ business plans against a range of climate scenarios and improve investment decision making. Why do investors choose engagement? Global collaborative investor engagement sends a powerful signal – directly to companies – that investors are asking for and expect companies to respond to climate change. Climate change is a systemic risk – one that investors cannot diversify away from. As equity investors and universal owners, investors have the ability and the responsibility to address climate risks and seek greater disclosure on how the most systemically significant emitters are aligning with the 2°C transition and disclosing climate change risks and opportunities to the market.

The growth in disclosure on environmental and other sustainability factors, prompted by regulators and bodies such as Climate Action 100+, the PRI and the UN-convened Net Zero Asset Owners Alliance and Net Zero Asset Managers Initiative (introduced in Chapter  3), seems likely to encourage increased levels of activism and engagement from individuals, NGOs and institutional investors as companies’ strategies, activities, operations and exposure to environmental and social factors become more widely known. There are a wide range of sustainability-related issues on which investors should seek to engage the boards and senior management of companies. These include, but are not limited, to: ●●

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a firm’s overall business strategy, and the activities and operations supporting this, and the extent to which this takes account of the transition to a sustainable, lowcarbon world; the impacts of physical, transition and liability risks; the quality, consistency and comparability of sustainability disclosures, so that investors can understand the positive and negative impacts of their investments (and, in the case of institutional investors, disclose their own financed emissions and other sustainability impacts); ­ hether there is a credible, Paris-aligned transition plan for firms that are currently w significant emitters of greenhouse gases, consistent with the Science-based Targets or other relevant framework; the capability and competence of the board and senior management in respect of climate change and other sustainability issues, and the capability and competence of the firm overall in implementing its sustainability strategies; and whether board and senior management incentives are linked to sustainability targets.

Responsible and sustainable investment

CASE STUDY Engine No.1 and ExxonMobil10 ExxonMobil is a multinational oil and gas corporation, and the world’s fifth-largest emitter of greenhouse gases. It has also been – at least in recent years – one of the worst-performing energy companies in terms of delivering returns to investors, underperforming its peers. In May 2021, a small activist hedge fund called Engine No.1 used its small shareholding (just 0.02 per cent of ExxonMobil’s shares) to try to change ExxonMobil’s strategy. It used its position as a shareholder to convince much larger investors, including BlackRock, Vanguard and StateStreet (who together owned some 20 per cent of ExxonMobil’s shares), to support its call for change. Delivering an 83-page presentation at ExxonMobil’s 2021 AGM, Engine No.1 told shareholders that: ●●

ExxonMobil had significantly underperformed relative to its peers;

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it had failed to adjust its strategy to enhance long-term value;

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its focus on chasing production growth over value had resulted in an undisciplined capital allocation strategy and had destroyed value; a refusal to accept that fossil fuel demand could decline in the future had led to a failure to take even initial steps towards addressing this, and managing the impacts of climate risks; and the lack of a successful transformation on the board had left ExxonMobil unprepared, and threatened continued long-term value destruction.11

The presentation convinced shareholders to overturn the recommendations of the existing ExxonMobil board and to replace three existing directors with individuals with backgrounds in renewable energy. This, they hope, will place ExxonMobil in a much better position to reduce emissions, manage climate risks and the transition to net zero, and deliver long-term returns for investors.

In practice, many investors and investment managers combine the sustainable investment strategies outlined above, or aspects of them, in their investment decision making, and fund and portfolio construction. This can involve, for example, an initial positive screening approach to identify a broad universe of potential investments, followed by a deeper analysis of a smaller selection of these. For investment advisers and managers in particular, the choice of sustainable investment strategy will depend on the characteristics, preferences, values and desired outcomes of clients and investors. Where those are more closely associated with seeking positive environmental

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and social returns, deeper green strategies may be adopted. Where investors’ preferences are influenced more by seeking to avoid climate and broader sustainability risks, lighter green screening strategies might be more apparent. As discussed above, much also depends on investors’ and investment managers’ resources, skills and time, as the analysis and engagement required for deeper green strategies is substantial.

READING Quintet Private Bank12 James Purcell, Group Head of ESG, Sustainable and Impact for Swiss-based Quintet Private Bank, shares his approach to investment strategy. He explains how he builds different strategies, such as Leader and Improver portfolios, using a range of different techniques. ‘Sustainable investing is far from binary; it is a powerful toolkit with which to build a portfolio. Just like how a conventional investor may blend growth and value strategies to create a portfolio that harvests different risk premia, a sustainable investor can combine sustainable leaders, improvers, themes, and dedicated assets to build a multi-asset portfolio with sustainability as a driver of returns. Leader strategies invest in those companies that are already performing strongly on sustainability matters – such companies often bring defensive characteristics to a portfolio. Improver strategies seek to identify companies that are making progress on the sustainability journey; as companies get better at managing their sustainability factors they de-risk, lowering their cost of capital and improving the predictability of their cash flows. Improver strategies diversify the traditional Leader approach. Thematic strategies focus on the technologies and services of the future economy. This differs from Leaders and Improvers that place greater emphasis on corporate practices. Thematic strategies often bring a strong growth component to a portfolio. Finally, dedicated assets are investments that are designed explicitly with sustainability as a defining characteristic. Some, such as green bonds, are excellent replacements for conventional assets classes – in this case, EUR and USD investment-grade credit. Others, such as microfinance, can bring decorrelation and diversification. In totality, sustainability can be deployed as a powerful toolkit, rich in narrative, and with a number of risk drivers and sources of return.’

Responsible and sustainable investment

Sustainable investment themes Thematic investing is an investment strategy that tries to identify long-term changes and trends and seeks to understand how these will impact firms, sectors and the economy overall. As we have seen throughout this book, climate change, and broader environmental and social sustainability factors, will impact all economic activities and entities, and particularly sectors such as agriculture, energy, infrastructure and transport. The physical, transition and liability risks of climate change will substantially increase costs and reduce returns from those sectors and firms most exposed to these, and asset stranding will reduce investment values, potentially to zero in some cases. Some sectors and firms will benefit from the transition to a more sustainable, low-carbon world, generating long-term financial returns alongside positive environmental and other sustainability benefits. A recent joint study by UNEP and the University of Oxford, for example, identified five major sustainable investment themes for the future: ●●

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Green energy: Investments in green energy can deliver high economic multipliers, have high potential to crowd in private investment and are an important step on the road to economy-wide decarbonization. Green transport: Compared with traditional alternatives, green transport investments can create many jobs quickly, while also creating long-term jobs in asset operations and management. They can also deliver high economic multipliers. Green building upgrades and energy efficiency: When effectively targeted, green building upgrades and energy efficiency improvements may be among the most effective economic stimulus tools available to policymakers. Natural capital: Economies are reliant on the natural world, and with large portions of natural capital under threat from deforestation or natural disasters, it is now more important than ever that policymakers take decisive action to protect and rebuild it. Green research and development: While the characteristics of research and development investment programmes differ from those of the other key policy areas, supporting these is crucial for the long-term health of economies and for our ability to address climate change.13

Similarly, the CFA Institute (2020) identified six key trends which, in its view, will underpin the future of sustainable investment; rather than taking a sectoral approach, though, it focused on global demographics: ●●

FinTech disruption: The use of FinTech tools and techniques (see Chapter  11) can support sustainable investment through enhanced availability and analysis

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of unstructured data, especially related to impact. This enables investors to have more customized sustainability objectives, uncover new investment opportunities and measure impacts more accurately. ●●

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­ arallel worlds: The growing inclination of consumers to express their preferences P and values in their consumption decisions will extend into personalization related to sustainable investment. We may also see more evidence of activists seeking to promote environmental and social change. Lower for longer: Low investment returns could make it challenging for some investors to increase their commitment to sustainable investment if there is an expectation or even a perception that there is a return trade-off. Investments in sectors such as renewable energy, energy efficiency and resource scarcity may benefit, however, from the search for higher returns. Purposeful capitalism: Investors are increasingly becoming more proactive in seeking environmental and social returns alongside financial returns. In addition, regulators have increased their focus on this. Climate energy: As carbon pricing and other policy and regulatory drivers develop, investors will move away from increasingly unattractive carbon-intensive companies towards lower-carbon alternatives. Social status: It will become a source of embarrassment to be unsustainable, and will be harder to hide the negative environmental and social impacts of business, as disclosure and reporting become more widely used, more transparent and more easily accessed and shared.14

QUICK QUESTION What themes do you believe will have the greatest impact on the global economy and investment? How will these impact your own savings and investment decisions?

Growth of sustainable investment In recent years, sustainable investment has gained substantial momentum in both retail and institutional markets. According to the Global Sustainable Investment Alliance, sustainable investment totalled $35.3 trillion in 2020, an increase of 15 per cent over the two-year period since 2018. Sustainable investment assets under management accounted for nearly 36 per cent of total global assets under management (an increase from approximately 33.5 per cent in 2018).15 Growth continued during 2021, although inflows into sustainable investment funds slowed in the second

Responsible and sustainable investment

half of the year, according to Morningstar. Globally, more than 1,000 funds were launched or repurposed as ‘sustainable’ during 2021.16 On the demand side, interest in sustainable investing among the general population of investors increased significantly: from 71 per cent in 2015 to 85 per cent in 2019, and in millennial investors from 84 per cent in 2015 to 95 per cent in 2019, according to the Morgan Stanley Institute for Sustainable Investing.17 At the institutional level, a study by Cambridge Associates found that the number of institutional investors globally reporting the adoption of sustainable and impact investment strategies had grown by 146 per cent between 2016 and 2020, with particularly marked growth in the UK and Europe – 250 per cent – between 2018 and 2020.18 Signatories to the UN Principles for Responsible Investment (PRI) commit to incorporating sustainable investment strategies in their investment decision making. According to the 2021 PRI Annual Report, 95 per cent of the growing number (more than 4,600) of PRI signatories in listed equity markets, 94 per cent in fixed-income markets and 92 per cent in private equity markets reported they incorporated ESG factors into investment decision making.19 In 2018, seven major groups working with investors (including the PRI, Carbon Disclosure Project (CDP) and the UNEP Finance Initiative (UNEP FI)) launched the Investor Agenda to better coordinate the growing range of investor initiatives, to support institutional investors tackling climate change and to showcase the actions some investors are already taking to improve their climate-related decision making and risk reporting.20 The Investor Agenda aims to encourage other institutional investors, asset owners and managers and pension funds, by means of peer pressure and the sharing of good practice, to scale up their sustainable investments to help support the transition to a low-carbon world. Its work covers four thematic areas: ●●

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Investment: Managing systemic climate risks in investor portfolios and supporting the transition by shifting capital to value-creating businesses set to succeed in a net zero future. Policy advocacy: Advocating for policies aligned with delivering a just transition to a net zero economy by 2050 or sooner. Corporate engagement: Engaging companies to drive and demonstrate real progress in line with a 1.5°C future. Investor disclosure: Enhancing investor disclosure to help stakeholders track investor action in line with a 1.5°C pathway.21

There are many interlinked factors that combine to drive the growth of sustainable investment, including changing demographics, and changing consumer and investor values and preferences, which we will discuss further on. Three key drivers, however, are the ‘3 Rs’: risk, regulation and returns, which we examine next.

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Risk As we have discussed in earlier chapters, there is now a much greater understanding, appreciation and disclosure of climate risks (physical, transition and liability risks) and a growing understanding of broader environmental and sustainability risks. Production or supply chain disruptions caused by the physical impacts of climate change lead to increased costs for firms, or increased investment in climate-resilient infrastructure and transport networks. Changing consumer preferences, alternative low-carbon business models and technologies, and evolving regulation to support countries’ and the global transition to net zero increase the transition risks faced by many businesses. Firms in high-carbon, high-emission sectors, and other sectors with a harmful impact on the environment or society, face increased costs from litigation and other liability risks. The Economist Intelligence Unit estimates that the negative impact of climate change on global assets under management is $4.2 trillion in present value, and will be $43 trillion by 2100.22 The Cambridge Institute for Sustainability Leadership has estimated that the effects of climate change on investments could lead to reductions of up to 45 per cent of the value of global equity portfolios, and of up to 23 per cent losses in fixed income (debt) portfolios.23 There are a wide range of impacts that could have significant effects on investments at the sector, regional, country and/or firm and asset levels, including: ●●

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Increased costs of physical risks associated with climate change, including the increased frequency and severity of extreme weather events. As we will see in Chapter  10, economic losses from such events have risen substantially over the past 30 years, especially in recent years. Increased costs of liability risks arising from harmful environmental impacts, and other higher regulatory costs. The introduction of realistic carbon pricing – the introduction of globally consistent carbon pricing of around $75 per tonne, as recommended by the IMF. Changing consumer preferences leading to a substantial decrease in demand for high-carbon and other unsustainable products and services. Heightened reputational risk. Significant asset impairment and stranding. As we have discussed in previous chapters, limiting emissions to restrict global warming to below 2°C would leave the majority of current oil, gas and coal reserves stranded.

Sustainable investment strategies can successfully mitigate against such risks, and there is evidence that this is happening. A Morgan Stanley report (2021), for example, concluded that sustainable investment contained less risk, regardless of asset class, compared with ‘traditional’ alternatives. Sustainable investments were also more

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resilient against market downturns and recessions, at least in the US: during 2008, 2009 and 2015, traditional funds in the US were much more likely to report a loss than sustainable funds. Sustainable investments were also found to perform better than their traditional counterparts during the initial phase of the Covid-19 pandemic, due to their lower exposure to carbon risk when demand for oil fell substantially in 2020.24

Regulation In earlier chapters, we examined the emergence and development of policy and regulation to lead and support the transition to a more sustainable, low-carbon world. As we have seen, to date much of this has been focused on addressing climate change, with the Paris Agreement (2015) supported by an increasing range of policy interventions at the global, regional (e.g. EU) and national levels. In financial services, regulatory priorities have focused on the identification, measurement and disclosure of climate risks, although central banks and financial regulators are now beginning to consider broader environmental and social sustainability factors as well. In addition, regulators, particularly in the UK and Europe, are increasingly taking active steps to support market integrity and avoid greenwashing and mis-selling by introducing new regulations on disclosure, and the labelling of funds and investments. Since 2020, the European Securities and Markets Authority (ESMA) has been required to take sustainability and ESG factors into account in its rulebook and supervisory activities. A new European Sustainable Finance Disclosure Regulation (SFDR) came into effect in March 2021; it requires disclosures of climate risks and other environmental and social factors.25 The EU Commission also plans to introduce new sustainable finance regulations that would amend MiFID II (the Markets in Financial Instruments Directive) and other EU legislation governing investments. These are expected to be introduced in 2022.26 They will require providers to incorporate sustainability factors into assessments of clients’ investment needs and preferences, with reference to the EU Taxonomy. In addition, sustainability factors must be integrated in investment managers’ risk management systems and investment due diligence processes, and disclosure will be significantly strengthened. National regulators in Europe are also taking similar approaches; German regulator BaFin, for example, is expected to introduce rules in 2022 to prevent greenwashing by requiring investment funds that describe themselves as ‘sustainable’ or similar to invest a minimum of 75 per cent of their assets sustainably, or track a recognized ESG market index.27 French financial regulator AMF has announced that sustainable finance, and in particular addressing the risks of greenwashing, will be priorities in 2022.28 In the UK, amongst other regulatory developments, the mandates of the Bank of England, the Prudential Regulation Authority and the Financial Conduct Authority were revised in 2021 to include addressing climate change. The Pensions Act was

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amended in the same year to include mandatory requirements for climate change governance and reporting, aligned with the recommendations of the TCFD. And, as set out in the next case study, the UK’s Financial Conduct Authority has released new guidance for investment funds to ensure market integrity and avoid potential greenwashing. In the US, the Securities and Exchange Commission (SEC) has announced mandatory rules for climate risk disclosures, aligned with the recommendations of the TCFD.29 In addition, the SEC is considering guidance for investment funds that describe themselves as ‘sustainable’ or ‘ESG’ similar to that being developed and implemented in the UK and Europe. Both the impact of existing regulation and the prospect of further policy and regulatory interventions (such as the introduction of more robust, global carbon pricing) drive the growth of sustainable investment. Regulation can increase the direct costs of holding high-carbon and other unsustainable assets, whilst the realistic prospect of future regulation increases transition risks.

CASE STUDY UK Financial Conduct Authority – ESG and sustainable investment funds: improving quality and clarity30 In July 2021, the UK Financial Conduct Authority (FCA) released new guidance for investment funds describing themselves as ‘sustainable’ or ‘ESG’. Noting the substantial increase in retail investor demand for such funds, and a corresponding rise in applications for authorization, the FCA wrote to investment managers to stress that funds marketed with a sustainability and ESG focus should describe their investment strategies clearly, and any assertions made about their goals must be reasonable and substantiated. Furthermore, the FCA noted that a number of applications for authorization had been poorly drafted and fell below expectations – they often contained claims about sustainable credentials and impact that did not bear scrutiny. Concerned about market integrity and the potential effects of misleading claims on consumers, the FCA has developed a set of guiding principles for the design, delivery and disclosure of responsible and sustainable investment funds. If consumers understand the basis on which sustainability claims are being made by fund and investment managers, and can monitor whether these claims are genuine, this should – in the FCA’s view – improve the functioning of the market. It should also reduce the risk that retail investors are buying products that do not meet their needs, and should create greater trust in funds described as ‘sustainable’ or ‘ESG’. The FCA’s guiding principles comprise one overarching principle and three supporting principles that focus on ‘design’, ‘delivery’ and ‘disclosure’.

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Overarching principle: consistency A fund’s ESG/sustainability focus should be reflected consistently in its design, delivery and disclosure. A fund’s focus on ESG/sustainability should be reflected consistently in its name, its stated objectives, its documented investment policy and strategy, and its holdings. The principle is accompanied by a set of ‘key considerations’, which add clarity and more detail as to how the principle can be met in practice: Principle 1. The design of responsible or sustainable investment funds and disclosure of key design elements in fund documentation. References to ESG (or related terms) in a fund’s name, financial promotions or fund documentation should fairly reflect the materiality of ESG/sustainability considerations to the objectives and/or investment policy and strategy of the fund. Principle 2. The delivery of ESG investment funds and ongoing monitoring of holdings. The resources (including skills, experience, technology, research, data and analytical tools) that a firm applies in pursuit of a fund’s stated ESG objectives should be appropriate. The way that a fund’s ESG investment strategy is implemented, and the profile of its holdings, should be consistent with its disclosed objectives on an ongoing basis. Principle 3. Pre-contractual and ongoing periodic disclosures on responsible or sustainable investment funds should be easily available to consumers and contain information that helps them make investment decisions. ESG/sustainability-related information in a key investor information document should be easily available and clear, succinct and comprehensible, avoiding the use of jargon and technical terms when everyday words can be used instead. Funds should disclose information to enable consumers to make an informed judgment about the merits of investing in a fund. Periodic fund disclosures should include evaluation against stated ESG/sustainability characteristics, themes or outcomes, as well as evidence of actions taken in pursuit of the fund’s stated aims.

QUICK QUESTION What regulatory developments have been recently announced in the market where you live and work, or a market you are familiar with?

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Returns Ultimately, the key driver of investment decision making for most investors and investment managers is financial, i.e. the expectation of achieving a market or above-market return. If sustainable investment strategies generate such returns, then regardless of investors’ preferences and values we should expect inflows to sustainable investments and funds. Historically, the consensus view was that sustainable investment led to a trade-off between financial and environmental and social returns. Companies that ‘do good’ would not also ‘do well’. Evidence is increasingly emerging, though, that sustainable investments at least match, and in some cases outperform their traditional counterparts: ●●

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I­n 2015, a substantial meta-study by researchers at the University of Hamburg and Deutsche Asset & Wealth Management concluded that there was a positive correlation between ESG investing and financial performance.31 Khan, Serafeim and Yoon (2016) studied the performance of US-listed companies listed on the MSCI KLD index (which tracks exposure to companies with positive ESG ratings) across a 21-year period from 1992 to 2013, finding that firms with higher ratings on material sustainability issues demonstrated better performance than companies with inferior ratings on the same issues.32 A recent study (Berchicci and King, 2021) seeking to replicate results demonstrated, however, that these seemed to have been caused by a statistical error, and the study’s conclusions should not be relied on.33 A 2019 study by Deutsche Bank, which analysed the corporate climate change disclosure and media reporting of 1,600 companies over a 20-year period found that those firms that reported positive impacts and results on climate change experienced, on average, a 26 per cent improvement in their share price compared with their peers. Negative impacts and reporting on climate change led to firms underperforming their peers.34 In 2020, Morningstar analysed the performance of 4,500 funds, and found that the majority of surviving ESG funds (those funds that had been in existence for 10 years or more) outperformed the average surviving traditional peer. The bestperforming ESG funds were US-based, where 70 per cent delivered higher returns than their traditional peers.35 UK investment manager, Fidelity, conducted a similar study in December 2020, analysing 2,659 equity and 1,450 fixed-income assets; it found a clear correlation between sustainability and returns. Interestingly, Fidelity noted that companies with ‘improving ESG’ performed better than companies with ‘stable’ levels of ESG.36 Morgan Stanley also found a correlation between higher ESG standards and stronger financial performance in their 2020 study. Drawing on an analysis of

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over 11,000 mutual and exchange-traded US-domiciled funds, they found that US sustainable funds outperformed their traditional peers by an average of 4.3 per cent in 2020.37 ●●

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According to research from the European Securities and Markets Authority (ESMA), published in 2022 but based on the performance of European retail investment products over the period 2010–20, funds that followed ESG investment strategies (broadly defined) outperformed their non-ESG peers. Within ESG funds, impact funds performed better than other types of ESG funds.38 ­ esearch by BlackRock (2022) found evidence of re-pricing of high- and lowR carbon assets, with the former forecast to fall by some 10 per cent and the latter rise by up to 8 per cent by 2025, although there would be a wide range of outcomes both between and within sectors.39

Possibly influenced by such results, investors increasingly seem to believe that sustainable investment can deliver higher returns than traditional alternatives. According to a 2020 global study conducted among institutional investors, 55 per cent believed that sustainable investment delivered higher returns, compared with 49 per cent of investors in 2019 and 34 per cent in 2018.40 There are several reasons why sustainable investments may outperform traditional equivalents. These include: ●●

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the avoidance or mitigation of climate risks (physical, transition and liability risks) and wider environmental and social sustainability risks, which are increasingly raising costs and reducing returns for high-carbon and other unsustainable assets and companies; the positive selection of assets and companies with new business models and technologies that will benefit from the transition to a sustainable low-carbon world, and associated shifts in consumer demand (the electric vehicle manufacturer Tesla is a well-known example of this); the increasing costs of regulation (as discussed above), which reduce the expected and actual returns from investments in high-carbon and other unsustainable assets and companies, and which may in some cases increase the returns from sustainable alternatives; the impact of stranded assets (and the potential for significant asset impairment and stranding), reducing demand for high-carbon assets and companies; the potential higher-quality leadership and overall management of companies comprising sustainable investment portfolios and funds (some suggest that high ESG scores and ratings act as a proxy for better strategic decision making, risk management and other factors); and evidence that investors and investment managers adopting sustainable investment strategies have a longer-term approach to investment (a longer time horizon) and are less likely to sell holdings during market downturns.

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Changing consumer and investor preferences and values also play a significant role in increasing demand for sustainable investments and funds, as we discuss in the next section.

Evolving investor preferences The emergence of millennials (the generation born in the 1980s and 1990s, becoming adults in the 2000s) and growth in the number of female investors as both retail investors and investment managers is increasing demand for sustainable investments, funds and related products and services. We should not assume that sustainable investing is limited only to specific demographic groups, however; it is an approach shared across generations and other socio-demographic categories. Older generations may be concerned about the impacts of global warming on their children and grandchildren, as well as on themselves. A Morgan Stanley report (2017) found that nearly 9 out of 10 millennial investors were interested in sustainable investment options that would produce market-rate financial returns alongside positive environmental and/or social returns. Millennial investors were almost twice as likely as non-millennial investors to invest in assets with specific environmental and/or social outcomes. They were also twice as likely to disinvest from assets harming the environment or society, compared with nonmillennial investors.41 Given that, in many developed markets at least, a significant inter-generational wealth transfer to the millennial and succeeding generations is anticipated, somewhere in the order of $30 trillion, there is great potential for very substantial and continued further growth in sustainable investment. Another factor supporting the further growth of sustainable investment – at least in some markets – is the impact of female investors. According to the Bank of Montreal’s Wealth Institute, women control more than half of private wealth in the US, and will inherit nearly 70 per cent of the $41 trillion expected to be passed on over the next 40 years.42 Surveys have shown that, in developed markets, up to 80 per cent of female investors expressed interest in sustainable approaches to investment; in many cases, female investors were twice as likely to show interest in sustainable approaches than male investors. In surveys of financial advisers, female advisers show greater interest in advising clients on sustainable investment opportunities than their male counterparts. A 2018 report from Moxie Future encompasses a wider range of markets, including China. Their findings revealed that, globally, nearly 70 per cent of women would be interested in sustainable investment if suitable products were available.43 Interest was highest among women in China (91 per cent), attributable to their exposure to highly visible environmental threats such as air pollution, which may at least to some extent be mitigated by supporting the growth of businesses and sectors supporting the transition to a more sustainable, lower-carbon world.

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A lack of gender diversity and other forms of diversity in investment management may hinder the development of products, services and funds tailored to meet the needs and preferences of women and other groups, however. Research by Morningstar (2020) found that only 11 per cent of fund managers in the US were female, a percentage that had not risen since 2000.44 A similar proportion of female fund managers were identified in the UK in a similar study undertaken by CityWire.45 The number of female fund managers, at least in the UK, was increasing very slowly, and the report’s authors estimated that it would take some 200 years at the current rate of progress to achieve gender parity. Given that female investment managers are even less represented in other parts of the world, this is problematic for the sustainable finance sector. There is also a general increase in environmental awareness that seems unlikely to diminish given the increased frequency and severity of extreme weather events and visibility of the physical impacts of climate change. This has been heightened by the Covid-19 pandemic; a 2020 Boston Consulting Group survey found 70 per cent of its 3,000 participants felt that they’d learned more about climate change caused by human activities since the pandemic, and 40 per cent were committed to changing their own consumption and behaviour to improve sustainability. A very high proportion of respondents – nearly 9 out of 10 – said companies should do more to integrate sustainability into their products, services and operations. The results were more pronounced amongst younger generations, who hold stronger views that personal choices and behaviour can make a difference in tackling the climate crisis, and expect sustainability to be a central part of governments’ and organizations’ plans to ‘Build Back Better’ after the pandemic.46 Environmental and other sustainability concerns are amplified by both traditional and social media. Social media platforms not only help traditional media outlets reach a wider audience, they can also amplify engagement with environmental and other issues, playing a major role in shaping and reinforcing consumer and investor preferences and values.

CASE STUDY Pensions – Make My Money Matter47 In June 2020, film director, producer and writer Richard Curtis (Four Weddings and a Funeral, Notting Hill) launched his latest project. Alongside former Governor of the Bank of England Mark Carney, and Nest CEO Helen Dean, he founded a UK-wide campaign: Make My Money Matter. The campaign aims to shift the £2.6 trillion invested in UK pensions away from fossil fuels and harmful investments towards more sustainable alternatives. Moving

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a pension into a sustainable fund is many times more effective in reducing one’s carbon footprint than not flying and going vegan combined – perhaps 27 times more impactful. According to a Make My Money Matter survey, over half (57 per cent) of respondents wanted their pension invested in sustainable assets, and 52 per cent wanted their pension money to go towards tackling climate change. Yet 72 per cent of British pension savers have no idea where their pension is invested, or if it is invested in line with their values.48 Make My Money Matter aims to change that.

Responsible and sustainable investment products and services The role of equity markets in the financial system Historically, equity markets have been the primary source of capital for companies, with total global equity market capitalization exceeding $100 trillion in 2020. This has changed in recent years, however. Large companies tend to use cash flow and debt to fund new investment, in part because in many jurisdictions the interest payments on bonds can be deducted against tax, and this is perceived as creating bias towards debt over equity for businesses raising additional finance. This may make it harder for smaller firms seeking investment in riskier, new technologies – including those developing technologies supporting the transition to net zero – to raise the funds they need to grow. In the last decade, large and mature markets, including the UK and US, have seen negative equity issuance, that is, more cash being returned to shareholders than capital being raised in new equity issuance. Equity markets remain hugely important, however, both as a source of capital (albeit a diminishing one in some jurisdictions) and in playing a vital role in terms of corporate governance and stewardship relating to company strategy and performance, capital allocation and – more recently – environmental and social sustainability. Also in recent years, there has been a significant shift away from Initial Public Offerings (IPOs) towards the secondary trading of shares (not raising new capital but buying and selling existing shares), with stock exchanges far larger and more complex/diverse in their services, and markets experiencing increased trading volumes with a significant role for automated and algorithmic trading. While this has led to the development of new types of products and services, trends have emerged towards increased short-termism and speculative trading, which may not support investment in new ‘green’ sectors and companies, which require longer-term ‘patient capital’.

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The diversity of equity markets means there is flexibility and a wide range of investment opportunities for retail and institutional investors with different characteristics and preferences. There is a very wide spectrum of potential investments that can support the transition to a sustainable, low-carbon world; they offer a variety of risks, returns and time horizons. Well-developed and liquid equity markets can match the demand for capital with funds from investors having corresponding risk and return appetites, and can play a major role in financing the transition to a more sustainable, low-carbon world.

Listed equities The landscape of equity markets is dominated by listed shares – equities listed on stock exchanges, publicly traded by retail and institutional investors (often investing on behalf of large pension funds). Market-weighted indices, like the FTSE 100 (UK), Nasdaq (US) or CAC40 (France) drive investment in these markets as many large funds (known as passive investors) track these rather than using their own analysis and decisions to decide what stocks to buy, sell or hold. Many active investors also mirror indices closely and/or mirror sector allocations (such as the proportion in sectors including finance, technology, manufacturing, high-carbon energy, renewable energy, infrastructure, etc.), if not the exact composition of shares. Large institutional shareholders can play a critical role as stewards of companies in which they invest. Stewardship is one of the main responsibilities of equity investors, who hold an ownership stake in a company and have the right (and, some would argue, the duty) to play an active role in ensuring that a company is governed responsibly in terms of its impact on all stakeholders, as well as in delivering returns to investors in the form of dividends and share value. Many institutional investors are committed to delivering long-term value for the owners of the assets in which they invest, as these are often linked to individual long-term savings in, for example, pensions. This suggests that they should seek to ensure that companies they invest in avoid excessive risk-taking, and promote environmental and social sustainability by adopting ‘very deep green’ investment and engagement strategies, as outlined above. Despite their longer-term time horizons, large investors can still be subject to shorttermism, however, due to the need for regular reporting and remuneration incentives for investment managers linked to short-term targets, which undermines their ability to prioritize long-term performance and sustainability. The situation has been improving in recent years, however. In 2020, for example, 99 per cent of FTSE 100 companies reported their GHG emissions (with 75 per cent reporting on Scope  3 GHG emissions), and 81 per cent assessed and disclosed climate risks, according to EcoAct.49 This represents a substantial increase compared with previous years (EcoAct has been tracking sustainability reporting since 2011),

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although the reporting of emissions does not mean that those emissions are aligned with the objectives of the Paris Agreement. In fact, according to data from Arabesque (March 2021, reported in the Guardian), almost one-third (31) of FTSE 100 companies’ current emissions were aligned with 2.7°C of global warming or above.50 A key driver of enhanced reporting is undoubtedly listing authorities’ and regulators’ focus on climate risks, in particular the adoption of TCFD reporting, especially as this becomes mandatory for listed firms in major financial markets. Companies – at least in the FTSE 100 – are increasingly reporting climate-related opportunities, too (70 per cent in 2020, according to EcoAct). These include the potential to develop new products, invest in renewables or improve operational efficiency, and reduce energy consumption and other costs.

Equity indices As we discussed in Chapter 7, in the context of green and sustainable bond indices, an index collects together a basket of similar securities, such as shares, and provides a benchmark against which investors can compare the performance of the shares they hold. There are a very wide range of equity indices, ranging from well-known indices such as the FTSE 100, the Dow Jones Industrial Average and the Shanghai Composite Index, which focus on companies with the largest market capitalizations, to highly specialized indices focusing on particular geographies, sectors and types of security. The rise in passive investing (where investors track the performance of a chosen market or index, seeking to achieve an average market return through a diversified portfolio) versus active investing (where investors make decisions based on their own analysis of companies and economic/market factors, usually seeking an above-average return) has led to substantial growth in equity indices. The growth of passive investing and of indices that focus on market capitalization and the largest listed companies, such as the FTSE 100, can be problematic for green and sustainable finance, since for the most part those indices favour highcarbon sectors and companies due to their size. This creates an uneven playing field, where newer and smaller companies have limited access to investors or are required to track such indices. This causes a misallocation of capital away from low-carbon, sustainable firms and sectors – and a financial risk, due to the fact that returns from high-carbon sectors can be expected to fall in value as a result of the transition to a sustainable, low-carbon world. We have already seen in Chapter 2 how the ‘carbon bubble’ can lead to significant asset impairment and/or stranded assets. Investors, investment managers and other key players in the investment chain (such as research providers, analysts, investment consultants) have made significant progress in recent years in understanding the risks and opportunities presented by climate change and broader environmental and sustainable factors. This has underpinned

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a shift away from carbon-intensive sectors and firms towards alternatives, particularly renewable energy; in addition, the fall in demand for fossil fuels caused by the Covid-19 pandemic has accelerated this. According to Carbon Tracker, despite equity issuance of $640 billion in fossil fuel-producing and related companies in the period 2011–21, the value of those shares fell by $123 billion in the period, underperforming the MSCI All Country World Index by 52 per cent. Fossil fuel issuance fell from $70 billion in 2012 to $10 billion in 2020. At the same time, total share issuance in renewables of $56 billion in the period gained $77 billion in value, outperforming the same index by 54 per cent.51 More recently, however, the war in Ukraine has seen the value of oil and gas, and related stocks and shares rise once more due to substantial increases in oil and gas prices. Reflecting this changing investor landscape and evolving investor preferences, the number of equity indices focusing on sustainability factors (often referred to as ‘ESG indices’) has grown rapidly in recent years, with more than 1,000 now available.52 Well-known examples of green and sustainable indices include the FTSE4Good, the Dow Jones Sustainability and the Nasdaq Green Economy Indices.

QUICK QUESTION What might be the drawbacks of relying on ESG and sustainable indices?

READING Characteristics of green equity indices53 The preferences for indices differ across countries and investors. In Japan, there is a focus on environmentally themed indices. Technology and social aspects (such as community investing) are popular in the United States, whereas in Europe the interest has been generally broad across all responsible investment (RI) approaches. Indices see rising demand for different strands and by all investor groups, driven also by changes in legislation, regulation and government initiatives (for example, ‘green ISAs’ in the UK). Indices also differ in terms of their approaches to the selection and weighting of index constituents. There are three basic approaches by index providers: 1 Screening: creating a green/ESG/SRI subset of a broader market index. 2 Best-of-class: for example, the top 20 per cent within a sector or industry (sometimes with neutral sector or country weightings).

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3 Re-weighting: adjusting the weightings of stocks in a standard market index in accordance with a green (carbon) factor, usually keeping sector weightings neutral to minimize tracking errors. Index providers use internal and/or external research resources to determine their green universes. Given the different approaches, it is no surprise that the definition of green investment varies across different indices. Some providers select green stocks on a qualitative basis, that is, because they operate in certain green sectors or produce green technology. Others take the whole stock market universe and specify ‘greenness’ quantitatively – for example, 50 per cent or more of the revenue needs to be climate change-related, or choose stocks with the highest contribution to reducing emissions. Finally, in a best-of-class approach, it is all relative, as the top 10 or 20 per cent of companies in a sector are selected. As a consequence, not surprisingly, the actual indices all look very different in every dimension, including the number of stocks, average size, liquidity and sector breakdowns. The outcome is a great variety among the constituent companies in the various indices. They range from small, highly specialized niche producers to wellknown global players that are deemed to be somehow ‘green’ or at least ‘greener than others’. There are limitations and weaknesses of green indices. Biases frequently found include (these do not necessarily apply to all indices): ●●

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size bias (overweight in larger stocks, or small stocks, depending on the index approach); and cyclicality.

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One of the challenges faced by green and sustainable indices is a bias towards large companies better able to meet index providers’ and investors’ demands for environmental and sustainability disclosures. Yet the ability to produce better disclosures does not necessarily mean that a company is better than its peers at managing climate risks, reducing emissions and/or taking advantage of opportunities from the transition to lower-carbon business models, merely that it is better than its peers at reporting. This has led to seemingly perverse index compositions – some high-carbon sectors and companies such as oil and gas producers and miners have appeared in ‘green’ and ‘ESG’ indices, for example, whilst renewable energy firms have been excluded. This occurs when ESG scores, ratings and indices focus on the process of disclosure (awarding high scores and ratings for reporting in detail) rather than on the actual contents of the disclosures themselves – but negative impacts on the environment and society cannot be offset by good governance and disclosure. Furthermore, smaller companies may lack the resources needed to disclose emissions and other metrics to the wide range of index providers and others seeking information, and may be excluded from some ratings and indices simply because they failed to report. Progress made in the quality of reporting, analysis and index construction has reduced this problem somewhat, but the challenge of verifying the extent to which quality of reporting is matched by high performance and the achievement of positive impacts remains a very serious one for companies and investors. A recent initiative to overcome the limitations of existing ‘green’ indices is the FTSE TPI Climate Transition index, launched in 2020 by the Church of England-led Transition Pathway Initiative and FT Russell, a large global index provider.54 The new index is designed to give higher scores to companies that set, disclose and make good progress towards targets aligned with the Paris Agreement, whilst giving lower scores to or excluding companies that fail to do so. It does this by combining historical disclosures with companies’ forward planning to capture both the risks and opportunities from the transition to net zero, measuring both: a the quality of companies’ management of greenhouse gas emissions and of the risks and opportunities related to the low-carbon transition; and b how companies’ planned or expected future carbon performance is aligned with the objectives of the Paris Agreement, and with international targets and national pledges made as part of the Paris Agreement. MSCI, another large global index provider, has also recently launched a range of global and regional Climate Change Indexes linked to alignment with the Paris Agreement. To be included, companies must meet a range of criteria such as reductions in emissions and annual decarbonization targets, whilst companies identifying and benefiting from opportunities from the transition to net zero are given higher weightings in the index.55

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Sustainable investment funds One of the most common ways for individuals (retail investors) to invest is through an investment fund. Funds combine a (usually) diversified range of assets to deliver a risk/return profile that matches investors’ characteristics, preferences and requirements. A very wide range of fund types exist, ranging in size, complexity, risk profile, geography, sector and selection criteria. Depending on the mandate, some funds are restricted to investing in certain asset classes only (for example, listed equities); some may be able to select investments across the whole range of asset classes introduced above. Some of the most common types of funds, including open-ended funds (unit trusts), closed-ended funds (investment trusts), exchange-traded funds (ETFs), index funds, hedge funds and private equity/venture capital funds, are described in this section in the context of (mainly) listed equities. Fixed-income funds (funds that invest in debt instruments such as green and sustainable bond funds, ETFs and index funds) were described in Chapter 7. As we described above, inflows into sustainable investment have grown substantially in recent years, totalling $35.3 trillion in assets under management in 2020 (nearly 36 per cent of total global assets under management) according to the Global Sustainable Investment Alliance.56 Bloomberg has forecast that global ESG assets will exceed $53 trillion by 2025, assuming 15 per cent growth each year.57 As we noted above, there has been significant growth in the number of funds labelled as ‘ESG’, ‘sustainable’ or similarly in recent years, with more than 4,500 such funds in Europe alone identified in 2021 (including existing funds repurposed/relabelled as ‘sustainable’). As we discussed in the introduction to this chapter, investors’ growing understanding of the risks and opportunities of climate change and broader environmental and sustainability factors (such as increasing carbon prices, litigation costs and other physical, liability and transition risks) may be altering the risk/return trade-off for many and driving the growth in demand for sustainable investment funds. Higher-thanaverage market returns from fast-growing asset classes (such as renewable energy and clean transport) and emerging evidence of consistent above-average market returns from sustainable investments, which we will examine later in this chapter, also account for the increased demand for sustainable investment funds, alongside investors’ own values and changing preferences. There may also be an element of potential greenwashing involved, however, where existing funds are simply relabelled and marketed as ‘green’ and ‘sustainable’ to investors without necessarily being aligned with objectives such as the Paris Agreement and/ or the UN Sustainable Development Goals, or without properly tracking the positive and negative impacts of investments. Some 256 European funds relabelled themselves as ‘sustainable’ or similar in 2020, following 179 funds in 2019, for example.58 This

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does not necessarily mean that greenwashing is involved, but investors and others – and especially Green and Sustainable Finance Professionals advising customers and clients – should take active steps to satisfy themselves of the sustainable credentials of such funds. As already noted, for this reason regulators and others are beginning to take action to develop clear criteria for funds labelled as ‘green’, ‘sustainable’ or ‘ESG’, and to identify and mitigate greenwashing. Such measures include, for example, the introduction of the EU’s SFDR.

Active vs passive investment strategies Funds are run by investment managers. They decide on the investment strategy, choose what companies to invest in and manage the portfolio, charging a management fee, and sometimes an additional performance-linked fee for their services. Managers may be individuals or groups of individuals/investment firms, and they may choose to adopt active or passive investment strategies, or a combination of both, including sustainable investment strategies as set out above. In simple terms, active investment strategies refer to approaches where investors or investment managers seek to achieve above-average market returns (or returns that outperform a selected benchmark) by selecting investments they believe will do this. Passive investment strategies are where investors or investment managers seek to achieve a market return by tracking a specific index; for example, the S&P 500 or the FTSE TPI Climate Transition index introduced in the previous section. Usually, active managers charge higher fees to reflect the costs of research into potential investments and more frequent transactions costs (as they tend to buy and sell investments more regularly). There is a lack of compelling evidence that active strategies overall achieve higher returns than the market average, or passive strategies, in the medium and long term. Some do, especially in the short term, but many do not. Over the longer term, passive strategies tend to outperform active strategies, with a key reason being that lower fees increase the returns to investors. In the context of sustainable investment, there is considerable debate over the respective merits of active versus passive investment strategies. Some argue that only an active approach, where investors and investment managers conduct detailed analyses of the environmental and sustainability impacts – both positive and negative – of potential investments, and engage with management to seek information and influence the direction of future strategy, is compatible with a ‘deep green’ approach. Simply tracking an index labelled as ‘ESG’ or similar, or even selecting investments on the basis of a simple ESG rating or score does not guarantee that an asset or company is truly sustainable, for the reasons we explored above. Perhaps for these reasons, the majority of funds described as ‘sustainable’, ‘ESG’ or similar currently follow active strategies, although the number of passive ‘sustainable’ and ‘ESG’ funds is growing rapidly, especially in Europe, according to Morningstar.

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As of December 2020, approximately 22 per cent of European sustainable investment funds adopted passive strategies, with total assets under management increasing from approximately €150 billion in 2019 to some €250 billion over a 12-month period.59 In the US, some 40 per cent of sustainable funds in 2021 had adopted passive strategies.60 As the number and quality of sustainable/ESG indices increases, and investors’/ investment managers’ confidence in the sustainability credentials of these grows, we can expect passive funds to continue to increase as a proportion of the overall sustainable investment fund universe.

QUICK QUESTION Thinking of your own savings and investments, would you tend to invest more in actively managed funds versus passive funds? Would you adopt or adapt your strategy in the context of sustainable investment?

Open- and closed-ended funds (unit and investment trusts) Many sustainable investment funds take the form of open- or closed-ended funds. Open-ended funds, such as unit trusts, are made up of units that are created by the fund manager when investors want to buy, and then cancelled/redeemed when investors want to sell. Open-ended funds are viewed as a relatively safe way for less experienced investors to invest. Closed-ended funds, sometimes called investment trusts, are listed on a stock exchange and their shares can be bought and sold like those of other listed companies. They are referred to as closed-ended because they raise a fixed amount of capital from investors. Both fund types can – depending on the fund manager’s mandate – adopt a variety or combination of investment strategies as described in earlier sections. There is a general perception, though, that closed-ended funds can be more complex and less suited to inexperienced investors. Investment trusts have become a common way of raising finance for renewable energy projects, and as such they have also become an easy and popular way for retail investors to gain exposure to this asset class. The first environmentally focused investment fund to be launched in the UK was the Jupiter Ecology Fund, established in 1988. There are now thousands of active and passive funds described as ‘green’, ‘sustainable’, ‘ESG’ or the like available in the UK, and indeed across all jurisdictions. Most mainstream fund managers now offer at least one such fund, and there are also numerous specialist fund managers taking advantage of increased investor demand. Choice and diversity bring many benefits, including lower costs for investors, greater liquidity and the ability to diversify green and sustainable investments across a range of funds and sectors.

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CASE STUDY Vanguard active and passive ESG funds61 Vanguard is one of the world’s largest investment management companies. As of 31 March 2019, Vanguard managed $5.4 trillion in global assets. The firm, headquartered in Valley Forge, Pennsylvania, offers 415 funds to its more than 20 million investors worldwide. In May 2019, Vanguard launched its first actively managed ESG fund, the Global ESG Select Stock Fund (VEIGX). The fund’s advisor, Wellington Management Company LLP, would focus on enhancing long-term returns and controlling risks by focusing on ESG practices that can materially impact shareholder returns. The firm intended to employ an active portfolio integration strategy to identify and select about 40 companies that demonstrate exemplary, long-standing ESG practices, strong business fundamentals and prudent capital allocation. To fully align the fund’s corporate governance responsibilities with its investment mandate, Wellington Management would also be responsible for the fund’s voting and engagement activities. Intended to be used within an existing diversified portfolio, the fund is designed for investors who wish to invest in companies with leading ESG practices and strong business fundamentals, as identified by Wellington Management. As Vanguard’s longest-serving external advisor, Wellington currently manages more than $360 billion on behalf of Vanguard across a variety of mandates. The firm has a strong history of ESG investing, and its world-class ESG research and investment teams seek to incorporate analysis of ESG factors into many of its investment and risk-management processes. New fund complements existing low-cost ESG offerings In recent years, ESG investing has grown significantly, and has attracted a diverse set of investors. Vanguard has offered ESG-focused funds for nearly 20 years, with 11 funds in the US, Australia and Europe totalling more than $10.8 billion in assets (in March 2019). At launch of Global ESG Stock Select, Vanguard offered a range of both indexed and active options for socially conscious investors in the US: ●● ●● ●●

Vanguard FTSE Social Index Fund (VFTAX) Vanguard ESG International Stock ETF (VSGX) Vanguard ESG US Stock ETF (ESGV)

To help further educate investors about ESG investing, Vanguard offers ‘ESG, SRI and impact investing: A primer for decision making.’

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As we have discussed earlier in this chapter, and elsewhere in this book, it can be difficult for investors to assess, track and compare the positive and negative environmental and other sustainability impacts of individual investments, portfolios and funds. Increased levels of transparency and disclosure, driven by investor pressure and regulation (such as the implementation of TCFD-aligned reporting) have enabled investors and others to improve their understanding of the sustainability policies and performance of companies. In turn, this – and stricter demands from financial regulators for disclosure on fund strategies and sustainability performance (as we saw above) – means that investment managers are now disclosing more detailed information about the composition and impacts of their funds. The lack of common definitions and metrics relating to sustainability factors still makes comparing different funds difficult, especially across jurisdictions, but the development of the EU and other taxonomies – alongside other regulations such as the EU SFDR to maintain market integrity – should improve consistency and help avoid greenwashing. Another issue for investors is that the rapidly increasing demand for sustainable investment funds means there is also substantial demand for green and sustainable assets that can be held by funds – and in some cases, a shortage of supply. This can lead to many sustainable funds holding similar assets, so investors holding several funds may not be as diversified as they believe. Also, demand for sustainable assets can lead to the inclusion in funds of some companies (such as, for example, CocaCola and McDonalds, which may score highly in some ESG metrics but not in others) that some investors – depending on their preferences and values – may not view as genuinely sustainable. Specialist financial advisers and consultants can help investors identify funds that meet their needs and preferences, and it is becoming easier for both professionals and retail investors to gain access to expert advice and a good range of products and services. The ethical investment adviser and manager Castlefield, for example, publishes its own analysis of the environmental credentials of sustainable investment funds each year, highlighting instances of both excellent and poor practice (see the Reading later in this chapter). A growing number of providers use data analytics and technology to assess and present companies’ and fund managers’ disclosures, issuing scores and ratings designed to help investors better understand the sustainability credentials of funds. In 2017, for example, Climetrics, part of the Carbon Disclosure Project (CDP) (see the case study below), launched a free tool that investors can use to assess the climate related-risks and impacts of some 18,000 funds.62 In 2018, Sustainalytics, a well-established ESG analytics and ratings firm, began to evaluate companies on their exposure to fossil fuels and the risks faced from the global transition to a low-carbon world.63 Arabesque (see the case study in Chapter 11) offers a similar service. Tumelo, a UK-based start-up,

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offers a dashboard enabling investors and their advisers to understand their holdings within pension and other funds more clearly, and to better assess their exposure to fossil fuels or more sustainable investments.64 Inyova, a Swiss FinTech, provides a platform to help retail investors create their own investment portfolio, using their preferences for different aspects of sustainability (such as climate change, reforestation, education) and their investment preferences (such as risk appetite).65

CASE STUDY How Climetrics rates funds66 Climetrics offers investors a simple means to understand their exposure to climate risks. Climetrics’ scoring system is based on three parts: each fund’s portfolio holdings, its investment policy and the asset manager’s governance. The purpose is to assess each fund’s entire investment process. Climetrics uses market-leading company data from CDP and ISS-climate, but also draws on additional data sources. Its methodology is fully transparent, and independently delivers up-to-date ratings for any fund in the available universe. The Climetrics rating measures the climate risk and opportunities of a fund against all other funds in its sample. Three quantitative layers of analysis produce an overall climate score for each fund, which is compared with all funds in the coverage and then assigned a final 1–5 leaf rating, with five being the best. Climetrics independently rates any fund for sale in Europe, with a minimum size of €150 million for equity funds, where at least 60 per cent of the portfolio’s assets under management must have Climetrics company scores and the full holding information is not older than 12 months. Five-leaf-rated funds must adhere to strict threshold criteria. A top Climetrics rating (4- or 5-leaf) indicates that, on average, the companies in a fund’s portfolio are: ●● ●●

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more carbon efficient; better at publicly disclosing and managing climate-related risks and opportunities; more likely to deploy key technologies supporting the energy transition.

Developments in disclosure, definitions, regulation and ratings services using data analytics to make it easier for investors to assess and compare the sustainability performance of investments and funds should, over time, improve market consistency and integrity in the use of terms such as ‘green’, ‘sustainable’ and ‘ESG’ in the

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marketing of investments and investment funds. If fund managers and advisers misuse such terms, however, this may amount to greenwashing – which can undermine confidence in the sustainable investment sector. As we saw above, this is a concern for regulators, and some are taking active steps to address the problem through their supervisory regimes.

Fund labelling Another way to bring clarity and consistency to the sustainable investment fund market, and in particular to make it easier for retail investors to identify funds that are genuinely sustainable, is through the use of fund labels. In this context, a label is a ‘badge’, based on a certification scheme, which verifies that a fund has met a minimum agreed standard relating to environmental and/or social sustainability performance. This is an approach that has been successfully applied in other markets, such as food (for example, the Marine Stewardship Council label) and a wide range of environmentally friendly goods and services (for example, the Nordic Swan Ecolabel). In the context of sustainable investment, and in particular that of trying to align finance with the objectives of the Paris Agreement and the UN Sustainable Development Goals, achieving a minimum standard may not be sufficient if the standard itself is not aligned with these. A number of labelling schemes have been established to identify investment funds that meet minimum standards for environmental and sustainability performance, especially in Europe. These include the IRS Label (France), FNG-Siegel (Germany, Austria and Switzerland), LuxFlag (Luxembourg), Towards Sustainability (Belgium) and the Nordic Swan Ecolabel itself, which has been recently extended to cover investment funds (Scandinavia). According to Novethic, by 2020 the French IRS and Belgian Towards Sustainability labels had been applied to the greatest number of funds (395 and 355, respectively), with a total of nearly 1,000 European funds labelled (some funds may choose to apply for two or more labels).67 As with ESG scores and ratings, as discussed earlier, the different methodologies adopted by different labelling schemes make it hard to compare investment funds. The EU is currently considering the development of an EU Ecolabel, linked to the EU Taxonomy for Sustainable Activities, with the aim of bringing consistency to fund labelling (in Europe, at least) to overcome this drawback.68

QUICK QUESTION How easy do you find it to assess the sustainability performance of your own savings and investments? What tools (such as ratings, scores, labels) are you aware of, and have you used?

Responsible and sustainable investment

Index funds As we discussed in the previous section, investment funds can adopt active or passive investment strategies. Index funds are a popular type of passive fund, where the fund’s portfolio tracks and holds the components of a market index (for example, the FTSE 100). Many index funds, especially those that track main market indices, such as the FTSE or Dow Jones, offer diversification and low management fees and operating expenses. They allow investors to buy and sell assets easily, they hold a more diversified portfolio and – depending on the index selected – they reduce risk. Index funds are not limited to equities; we introduced green and sustainable bond index funds in Chapter 7, for example. As set out above, in recent years many green, ethical, ESG and sustainability indices have been launched. These are developed and provided by stock exchanges (for example, FTSE Global Climate, FTSE4Good), financial data providers (for example, MSCI ESG Index) or fund managers (for example, First Trust Nasdaq Clean Edge Green Energy Index Fund). Although these are more specialized than main market index funds, and sometimes have higher fees and expenses, sustainable index funds can attract greater investment in environmentally and socially sustainable assets through funds that are simplified, diversified and have reasonable costs and expenses. As we have discussed, however, indices are criticized for potentially offering a misleading picture of sustainability; some ESG and sustainability indices, for example, have included major oil and gas companies, airlines and airport operators. This is because indices may weight factors including disclosure, governance and fair working practices highly, meaning a low ‘E’ rating is outweighed by high ‘S’ and ‘G’ ratings. Furthermore, some of the most significant emitters of greenhouse gases, such as Shell, are also some of the largest investors in clean energy and other low-carbon technologies, which might also give them a higher ESG or sustainability rating, depending on the methodology adopted by a given rating or index provider. Without looking at the component shares in an index, therefore, investors cannot be sure whether investing in an index fund labelled as ‘sustainable’ is actually the case. Recent initiatives, including the FTSE TPI Climate Transition and MSCI Climate Change Indices introduced above, seek to overcome this, however, by overweighting stocks that set, disclose and make good progress towards targets aligned with the Paris Agreement, whilst underweighting or excluding those that do not. The development of more specialized and robust indices aligned with the Paris Agreement and other science-based targets seems likely to continue, and should give investors greater confidence in index-tracking funds.

Exchange-traded funds (ETFs) Exchange-traded funds (ETFs) act in a similar manner to index tracker funds, and aim to provide investors with a return that matches the return on a set of specified

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assets, such as an equity or bond index, a basket of currencies or commodities, or almost any other set/combination of assets. In the case of ETFs, however, an investor is buying a promise by the issuer to provide that return, rather than buying any direct interest in the underlying assets themselves. The return may be generated by buying the underlying assets, but often is composed of a wider range of financial products, including futures and derivatives. Shares in ETFs are listed on a stock exchange, and can be bought and sold at any time, which can lead many investors to assume that ETFs are more efficient for investors (as an investor does not need to buy or sell what might be a large number of underlying assets and shares, just an ETF share). However, there can be tracking errors, as some ETFs use complex combinations of products to try to match the performance of underlying assets. In addition, investors are exposed to credit risk in relation to the issuer of the ETF, as it is the issuer who is ultimately responsible for maintaining the value of assets to back the shares that are issued. In recent years, the ETF market has grown rapidly, with nearly $10 trillion of assets under management in 202169 – a fivefold increase over a decade. BlackRock forecasts annual inflows of $1 trillion or more each year to 2024.70 Taking advantage of investor demand, providers have launched an increasing range of ETFs in recent years across many asset classes, including sustainable/ESG-labelled ETFs. According to FT Adviser, in 2021 more than 170 such ETFs were launched, and in Europe ESG-labelled ETFs captured half of all inflows to ETFs during the year.71 Advantages of ETFs ●●

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Flexible trading – ETFs can be traded at any time of day, with no minimum investment and without the redemption fees and other costs associated with other funds. Variety – ETFs can be bought and sold anywhere, and can be structured to mimic the performance of a huge range of assets and products. ­ educed costs – Not having to buy and sell underlying securities means that R management and trading costs are reduced, and so, in theory, more of the capital return can be passed on to the investor.

Disadvantages of ETFs ●●

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Additional fees – brokerage commissions are paid each time ETFs are bought or sold. Price spread – the structure of ETFs means there is sometimes a wider bid/ask spread, meaning investors may have to buy at a slight premium and sell at a slight discount, especially if liquidity is low or market volatility is high.

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Risk – as an ETF is effectively a promise by the issuer to pay a return based on a formula, in reality the ETF investor is exposed to counterparty risk in relation to the ability of the issuer to pay (in addition to market risk in relation to the value of the underlying assets of the actual ETF).

QUICK QUESTION What might be the advantages and/or disadvantages of ETFs for green and sustainable finance?

Many ETFs seek to replicate the return of the underlying asset by using a range of different investments, rather than by actually buying the underlying assets themselves. The relationship between market prices and capital flows means that it is not simple to judge the impact of ETF investing on the underlying companies or assets. There is a valid question, however, as to whether the claimed trading liquidity and efficiency benefits of ETFs for investors are sufficiently important to choose this form of investment rather than products that invest directly in the underlying shares or other assets. This is relevant to green and sustainable finance because, given the need for investment capital to be channelled to investments that support climate change adaptation and mitigation, if capital is utilized in general financial instruments of this type it may not be available for sustainable investment that generates positive environmental or social benefits. Like many sustainable investment fund types, a large number of ETFs describing themselves as ‘sustainable’ or ‘ESG’ focus on renewable and clean energy technologies. The range of options and issues that underpin the selection criteria for the assets are generally the same as for sustainable investment funds themselves. The removal of the need to actually buy the underlying assets (which may be in limited supply) potentially removes some restrictions regarding the supply of sustainable assets that meet funds’ criteria, however. Thus, investors are able to gain access to sustainable assets without necessarily owning the assets themselves. Examples of such ETFs include: ●●

iShares ESG MSCI Global Impact

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iShares S&P Global Clean Energy

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First Trust Global Wind Energy

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­First Trust Nasdaq Clean Edge Energy

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A listing of many (but not all) ESG-focused ETFs, described in this case as ‘socially responsible’, is published by the ETF Database.72 As with other types of investment funds, ETFs have been criticized for potential greenwashing, since some funds labelled as ‘green’ and/or ‘sustainable’, by their nature of following indices or another selected basket of assets, may have significant exposure to fossil fuel and other less sustainable investments. Developments in fund regulation and supervision, and fund labelling, as described in previous sections, should help maintain market integrity.

Hedge funds Hedge funds are actively managed and seek to generate ‘alpha’, which means outperforming the market by achieving above-market returns, rather than seeking to replicate these, as an index tracking fund might. As they are only allowed to accept investments from professional investors, hedge funds for the most part are not regulated like banks or other investment funds, which means they can invest in almost any asset class and use almost any investment strategy they choose. This freedom means that hedge fund managers can, if they wish, choose a combination of very specific sectors or assets that are often highly correlated, concentrating risk in anticipation of higher returns. This will often involve the use of specialist analysis and market intelligence, and increasingly involves the use of complex algorithmic trading strategies and techniques such as high-frequency trading (HFT). These are controversial due to their potential to cause high levels of volatility and obscure the market for genuine investments in productive economic activities. Hedge funds may also adopt thematic investment strategies based on the transition to a sustainable, low-carbon world, including investments in new and potentially high-growth sectors such as renewable energy or clean technology; they may also pursue opportunities to trade in new markets, such as those for carbon credits. These are good examples of sectors where mainstream financial markets have difficulty investing without the support of development banks or other policy interventions because there may be limited data on historical performance, or because of the ‘stickiness’ of assumptions and market behaviour. This is due, in part, to the pressure of having to follow overall market sentiment to match indices or seek to maintain returns in the short term, rather than having the ability to anticipate transformative shifts and disruptions and to invest in long-term value.

Responsible and sustainable investment

CASE STUDY Cumulus Climate Fund73 Cumulus (in meteorology: low-altitude, fluffy clouds) is well named, as the fund began identifying discrepancies in weather forecasts which created arbitrage opportunities for trading in weather derivatives. Launched in 2006 in London by Peter Brewer, a weather risk management expert, in its first 10 years of trading it generated substantial returns for investors totalling almost 1,000 per cent. As Cumulus grew, with assets under management exceeding $2 billion by 2015, two separate funds were created: ●●

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The Cumulus Fahrenheit Fund, which continued to focus on trading weather derivatives The Cumulus Energy Fund, which followed a strategy of applying the fund’s expertise to the European energy sector

After several more successful years of trading for both funds, in 2018 the funds were closed and the capital returned to investors. Peter Brewer and many of his colleagues from Cumulus moved to a large hedge fund manager called Citadel, which offered opportunities for them to pursue climate- and weather-related investment strategies on a larger scale.

Private equity, venture capital and angel investing Private equity Private equity refers to investment capital raised outside the public markets of listed equities, and covers a range of financial instruments that share in the profits and losses of a business. This includes, but is not limited to, share capital, and frequently involves a combination of equity and debt. Private equity fund managers have traditionally charged a management fee in proportion to the amount of funds invested, and a performance fee linked to the returns made. A common formula is referred to as ‘2 and 20’ – a 2 per cent management fee, plus 20 per cent of any returns realized. This creates powerful incentives for private equity fund managers to take greater levels of risk (albeit carefully calibrated and selected risk) in the expectation of generating higher returns. Most private equity investment is conducted by private equity funds, which are normally structured as limited liability partnerships. Institutional investors and wealthy institutions, including endowments, hedge funds, and high-net-worth

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individuals (known as ‘limited partners’) invest alongside the private equity fund managers themselves (known as ‘general partners’), who put some of their own capital at risk in investments (often described as having ‘skin in the game’). It is common for private equity funds to borrow substantial sums to finance acquisitions, which are known as ‘leveraged buyouts’. This also creates incentives for managers to generate high returns to repay the debt incurred in acquiring the asset(s) or firm(s). Private equity investors may take either minority or majority stakes in companies, but in both cases tend to play very active roles in engaging with or joining the management team. They tend to seek returns in the form of capital growth in the value of a business, rather than short-term income, as private equity is primarily a ‘buy-to-sell’ business model, with investors looking to boost value and then sell the assets in (often) a 5- to 10-year timeframe (known as the ‘exit’). Assets may be sold via a trade sale to another private equity fund or manager or, as is often the case for high-growth technology businesses and others backed by private equity, through an Initial Public Offering (IPO). The characteristics of private equity investment – a higher appetite for risk, a multi-year time horizon and specialized skills in business transformation and innovation – mean that it can be well suited to support some emerging areas of green and sustainable finance. For example, companies that need to transform their business model to align with the transition to net zero may need capital, expertise and time in order to do so. Companies in new sectors or technologies, including renewable energy or clean technology, might have high potential but present risks and uncertainties that more traditional investors cannot take on. In both cases, a private equity investor may have the appetite, skills and access to capital to take on those risks and support a period of change or growth in return for the chance to share in substantial capital growth and a successful exit. According to a 2022 report from TheCityUK, globally the consumer cyclical sector (which includes consumer retail, auto, residential construction, leisure and entertainment) received the majority – nearly 53 per cent – of green private equity investment over a 10-year period, totalling $26.8 billion.74

Venture capital Venture capital refers to a specific type of private equity investing, rather than to a separate approach altogether. Venture capital differs in that there is a greater emphasis on investing in and developing new or early-stage businesses, which means the risks tend to be greater and failures more numerous, but the pay-offs can be substantial for successful investments. For venture capital funds to be profitable, it is necessary to deliver a small number of ‘home-run’ successes, perhaps increasing in value by 10 or even 100 times, to outweigh the many failed ventures. The technology sector is a good example of a sector where this model has been highly influential.

Responsible and sustainable investment

Venture capital funds may be established by private groups of investors (in which case they are very similar to private equity partnerships) but focus on investing at an earlier stage. Recent years have seen the growth of venture capital funds established by large corporations seeking to identify, spur and support innovation that might be difficult to promote within the culture of a large organization. In financial services we have seen something similar, with banks and other financial services organizations setting up or partnering with FinTech incubators rather than trying to match the speed and agility of FinTech innovation in-house. Nearly two-thirds of total private equity investment in the green and sustainable finance sector between 2012 and 2022 was venture capital, according to TheCityUK study referenced above.75 This is not surprising, given the emergent nature of many of the sustainable firms and technologies financed during the period. As the sector has begun to mature, larger corporate venture capital funds have grown considerably in recent years, with many led by utilities (for example, EnBW New Ventures, a €100 million fund set up by a large German utility company76) or other corporations facing significant costs and change from climate risks (for example, Alliance Ventures, a €1 billion fund established by Renault, Nissan and Mitsubishi focused on clean and smart transport77). Many different venture funds of different sizes exist, specializing in different areas of climate change mitigation and adaptation and having different investment strategies. Ecosummit is a Berlin-based organization promoting green and sustainable venture capital; it runs regular events that bring together venture capital funds and the founders of new sustainable businesses.78

Angel investing A type of very early-stage venture capital investing is referred to as ‘angel investing’, where (usually) wealthy individuals, often successful business people, invest financially and offer advice, expertise and contacts to entrepreneurs. Angel investing can be used to help entrepreneurs fund a proof-of-concept, and perhaps a limited trial, following which additional capital from venture funds and others such as those described above might be sought to build a more substantial business. While there may be an element of impact investing, in many cases angel investors expect to make financial returns, although they accept that – as with venture capital – investments will need to be spread across a wide portfolio, as a small number of highly profitable investments are required to balance the large number that fail. Some angel investors act alone; others form investment syndicates to share risk and pool expertise and networks. Many syndicates choose to specialize in particular sectors, and we are beginning to see the emergence of angel syndicates with a focus on climate change mitigation and adaptation projects. One of the most established of these is the UK’s Green Angel Syndicate, founded in 2013, which focuses on investments in clean energy, water, sustainable transport and smart cities. As well

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as providing early-stage funding for innovative technologies and businesses seeking to support the transition to a greener economy, syndicate members – many of whom have expertise in green and sustainable business, finance and technology themselves – offer guidance, support and access to business networks to help the early-stage investments grow.

CASE STUDY Green Angel Syndicate79 Founded in 2013, the UK-based Green Angel Syndicate seeks innovations that will make a difference in tackling climate change, and then invests in them to enable their development. This is grounded in the view that widespread systemic change requires a range of innovations. Multiple small inventions are needed to make incremental changes at the global scale. The expertise of syndicate members, many of whom have backgrounds in energy, the environment and sustainable finance, enables rigorous due diligence reviews to be conducted on the environmental and financial performance of potential investments. As of end of December 2021, the Green Angel Syndicate has: ●● ●●

attracted over 300 members; invested more than £10 million in 28 start-up or early-stage companies across 10 different economic sectors;

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saved nearly 20,000 tonnes of CO2e;

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won the UK Business Angels Association Angel Syndicate of the Year 2019.

The Syndicate’s portfolio (which can be viewed at https://greenangelsyndicate.com/ portfolio) encompasses companies in the agritech and water, built environment, energy, transport and waste and recycling sectors, amongst others. Since 2020, the syndicate has been publishing impact reports twice a year in which it estimates the quantity of greenhouse gas emissions avoided by portfolio companies, including the methodology used for calculating this. The syndicate also publicly reports its own carbon footprint. Investments’ impacts in terms of the wider UN Sustainable Development Goals are also reported. In 2021, the Green Angel Syndicate launched a Climate Change fund to enable investors to invest in a diversified portfolio of early-stage companies held by the syndicate (https://climatechangefund.co.uk).

Responsible and sustainable investment

There are clear advantages to private equity investment, particularly in terms of channelling investment to emerging, riskier, green and sustainable business models, firms and technologies. There are also concerns and potential drawbacks, however. Lower levels of transparency in private markets can make it hard for investors or other stakeholders to assess the performance or impacts of privately held companies. This can be the case both for financial performance and for environmental and wider sustainability performance – privately held companies are not, in most cases, required to publicly disclose such information. Pressure to deliver the high levels of return demanded by investors who are taking on risk through private equity deals can negatively affect decision making in investee companies; for example, by forcing cost cutting that affects wages for workers or encourages over-exploitation of resources or low standards of environmental conservation. Private equity investments have also been associated with the use of complex corporate structures, financing arrangements and tax havens, which bring the risk of negative publicity and reputational damage or regulatory pressure.

QUICK QUESTION How can the distinctive characteristics of private equity investment be mobilized in support of green and sustainable finance?

Challenges to the continued growth of responsible and sustainable investment As we have seen throughout this chapter, the sustainable investment sector is growing rapidly in terms of scale and scope. This is driven by a range of factors that include: a greater appreciation and understanding of climate and wider sustainability risks and opportunities; developments in regulation and policy at national and international levels designed to support the transition to net zero; increasing evidence of returns from sustainable investment strategies; and changing investor demographics, preferences and values. There are some significant challenges to the continued growth of sustainable investment, however, which we explore in this section: ●●

a lack of capacity and capability;

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the need to adapt the concept of fiduciary duty;

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the issue of short-termism.

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Improving the credibility, consistency and comparability of data to enable investors and investment managers to better understand and compare the sustainability impacts and performance of investments is also a key challenge. This was explored in detail in Chapters 4 and 5, and so is not reprised here.

Capacity and capability – preventing greenwashing We introduced the concept of ‘greenwashing’ in Chapter 1, defining it as ‘Inadvertently or deliberately misleading others about the environmental or broader sustainability benefits of an activity, project, product or service.’ We also referred to it on several occasions earlier in this chapter, and have presented some of the recent regulatory interventions designed to prevent greenwashing in the sustainable investment sector, such as the EU SFDR. A survey by global asset manager Schroders (2021) surveyed institutional investors across 26 countries. The majority (59 per cent) believed greenwashing was the greatest challenge to sustainable investing.80 As we set out in Chapter 1, there are many different types of greenwashing. In the context of sustainable investment, these may include: ●●

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deliberately describing an investment or investment fund as ‘green’, ‘sustainable’, ‘ESG’ or the like when in fact this description cannot be supported by the environmental and/or social benefits involved (or, in extremis, when investments in fact cause harm to the environment or society); describing an activity, product or service as ‘green’, ‘sustainable’ or the like without monitoring and verifying outcomes (or disclosing where this has not been done), so the environmental and sustainability benefits are not truly understood; deliberately or inadvertently overstating the environmental or societal benefits of an investment or investment fund; highlighting the positive environmental or societal benefits and impacts of an investment or fund whilst failing to mention related detriments; and investors and investment managers making public commitments to environmental and social sustainability (for example, by joining investor groups) that are not backed by consistent action and/or are contradicted by their activities.

QUICK QUESTION Have you come across any examples of greenwashing in the financial services sector? If so, in your view were these deliberate or inadvertent?

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As demand for sustainable investment grows, the incentives for deliberate greenwashing increase. At the same time, the rapid growth in sustainable investment, and green and sustainable finance overall, has not been matched by similar growth in the numbers of professionals with the knowledge and skills required to design, deliver, advise on, question and monitor financial products and services, including investment funds and others, that are genuinely sustainable. This lack of relevant professional knowledge and professional scepticism can lead to an increase in inadvertent greenwashing, which in turn may lead to decreasing consumer and investor confidence in the responsible and sustainable investment sector. Capacity and capability are, therefore, significant constraints to the continued growth of green and sustainable finance. Although it is difficult to measure, most greenwashing in the sustainable investment sector appears to be inadvertent rather than deliberate. The Economist analysed the world’s 20 largest ‘ESG’ labelled funds in 2021, for example, and found that each invests in 17 fossil fuel-intensive companies on average – with some funds even investing in coal producers.81 A purist view would be that no ‘sustainable’ fund could ever invest in such businesses. Others, though, would argue that investing in highcarbon sectors and firms that are committed to transitioning to low-carbon business models aligned with the objectives of the Paris Agreement and other sustainability goals is a realistic (and necessary) approach to sustainability. The key to resolving this is data and transparency: credible, consistent and comparable disclosures of key environmental and other sustainability metrics enable investors and investment managers to make informed decisions on the sustainability benefits and harms of potential investments. As we have seen in earlier chapters, however, there is still a great deal of work to be done on data availability, analysis and quality to make this a reality for most. ‘Big data’ and data analytics are increasingly being used to help investors and investment managers understand the sustainability credentials of funds and their underlying investments, as we saw in earlier sections above.

READING Winners and Spinners – Castlefield calling out greenwashing82 The Castlefield Winners and Spinners report delves beneath the ‘ethical’, ‘ESG’ (environmental, social and governance) and ‘sustainable’ fund labels and claims. Their aim is to expose the fund managers whose so-called responsible investment offerings fail to deliver the values expected by investors – and to spotlight the achievements of those providers genuinely walking the ethical walk as well as talking the talk . . . Identification of Spinners involves a sharp eye for greenwash in marketing material, or for funds whose make-up means they’re ethical in name only.

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Winner 1: FP WHEB Sustainability Fund The WHEB Sustainability Fund has been named in every report since 2012. The team aims to deliver a positive impact by following nine investment themes, looking for ‘companies with solutions to the sustainability challenge of moving to a zero-carbon economy’, according to managing partner George Latham. Within that universe, the team seeks out high-quality, resilient businesses with good management and a robust structure, that are set to grow market share. As an impact investor, WHEB expects active involvement with the companies it invests in. The investment team also continues to raise the bar in terms of its commitment to transparency for investors, including publishing the minutes of all its investment advisory committee meetings, at which the fund’s independent advisory panel assess and challenge the team’s investment decisions. Sharing the minutes gives investors in the fund real insight into the team’s justifications for stock selections and how they fit its positive impact mandate. In addition, as an impact investor committed to providing investors with measurable real improvements for the planet, WHEB has built an online ‘impact calculator’ where investors can see the difference their holding has made over a specific period. More generally, with only one fund and a single strategy, WHEB has made a point of embedding its ethos of positive impact throughout its entire business, becoming a Certified B Corporation. Spinner 1: The Future World Girl Fund The full name of this fund, launched in September 2018, is the Legal & General Future World Gender in Leadership UK Index fund, and it invests in companies based on how they are performing against four measures of gender diversity. The marketing material talks in great detail of the business benefits of diverse teams, which is a sentiment Castlefield agrees with and is backed up by academic evidence. However, a closer look at the index followed by the fund – the Solactive L&G Gender in Leadership UK Index – reveals that it has been outsourced to a company with an all-male management team. In addition, as the presence of Royal Dutch Shell, BP and British American Tobacco in the top 10 holdings makes clear, there is no consideration of the environmental or social aspect of the companies in which it invests.

Responsible and sustainable investment

The Castlefield case study shows how investors, particularly those lacking the resources, skills and time, face significant challenges in identifying truly ‘green’ and ‘sustainable’ investments. Castlefield’s leading fund is from a specialist sustainability fund manager (WHEB), and its lowest performer comes from the portfolio of a large asset and fund manager (Legal & General). It is not a given that larger asset managers will have less innovative or stringent approaches to sustainable funds, but there is often good reason for values-based and impact-driven investors to consider more specialist offerings, as these are perhaps less likely to compromise on environmental, sustainability and other factors to make their funds more attractive to a wider investment base. Such funds may, however, be more difficult for many retail investors to identify and invest in.

Fiduciary duty Fiduciary duty is a legal concept common to many jurisdictions, in accordance with which agents must act in the best interests of the individuals or organizations they represent. In the investment context, this refers to investment managers and other advisers using due skill, care and diligence in making investment decisions on behalf of their clients, including retail and institutional investors. The traditional (and, for many, current) concept of fiduciary duty is considered in the context of financial returns from investments only – i.e. investment managers and other advisers have a duty to maximize financial returns subject to investor characteristics, preferences and risk appetites. This can be problematic for sustainable investment, as it suggests that those making investment decisions on behalf of others do not necessarily need to consider environmental and social sustainability factors unless these are clearly expressed by the investors. If they were to do so, they could potentially be subject to legal challenges based on this traditional view of fiduciary duty. As we have explored in this chapter and elsewhere in this book, the growing understanding and appreciation of climate risks (physical, transition and liability), and awareness of the opportunities and financial returns available from supporting the transition to more sustainable, low-carbon business models, have altered the risk/ return profile for many. Changing investor preferences and growing evidence of aboveaverage market returns from sustainable investments mean that sustainable investment strategies and a traditional approach to fiduciary duty are not necessarily incompatible. A revised approach to the concept of fiduciary duty that takes sustainability factors into account has been developed and codified by the Principles for Responsible Investment (PRI) and the UNEP Finance Initiative (UNEP FI). ‘Fiduciary Duty in the 21st Century’ argues that acting in the best interests of clients and using due skill, care and diligence means that investment managers and others must incorporate sustainability factors into investment decision making in order to fulfil their fiduciary

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duty. This is because (a) incorporating such factors has now become accepted market practice; (b) sustainability factors are financially material; and (c) policy and regulatory frameworks increasingly impose a legal duty to consider such factors. Investment managers and others should, therefore: ●●

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incorporate ESG issues into investment analysis and decision-making processes, consistent with investors’ time horizons; encourage high standards of ESG performance in the companies or other entities in which they invest; understand and incorporate beneficiaries’ and investors’ sustainability-related preferences, regardless of whether these preferences are financially material;

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support the stability and resilience of the financial system; and

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report on how they have implemented these commitments.83

Incorporating sustainability factors into the concept of fiduciary duty has been a priority for some financial regulators, too. In April 2021, for example, the European Commission amended six acts that require financial firms – including institutional investors – to embed financially material sustainability risks in their procedures.84 In addition, investment managers and advisers must consider the sustainability preferences of their clients. Whilst the concept of fiduciary duty is evolving in a direction that supports the integration of sustainability factors, strengthened by the development of regulation, a consistent global approach is required so that the concepts of fiduciary duty and sustainability are fully aligned.

Short-termism In Chapter 1, we introduced the issue of short-termism – the problem that the time horizons in which investors and others make decisions are often too short to incorporate longer-term environmental or social impacts. This leads to the ‘tragedy of the horizon’ – imposing costs on future generations that those making decisions today may have no direct incentive to avoid. Despite a growing appreciation of climate, environmental and sustainability risks, and of the opportunities from investing in the transition to a more sustainable, low-carbon world, investors and investment managers can still in many cases be incentivized to maximize returns in the short or medium term. This is not always compatible with the longer-term, ‘patient capital’ approach needed to support the development of new, low-carbon technologies and business models, and/or the transition of sectors and firms to more sustainable models of production and distribution. In the reading below, Head of Behavioural Science for Oxford Risk, Greg Davies, explains more.

Responsible and sustainable investment

READING Short-termism and investment psychology85 Is short-term thinking sabotaging long-term sustainability? It invariably does! Sustainability inherently requires genuine consideration of longerterm outcomes and trade-offs . . . and yet we fallible humans make every decision in the present, based on our myopic view of what matters, and in the context of our current emotional state and concerns. This means that almost all decision making is biased in some degree away from long-term sustainability. In particular, we are always more likely to focus on solving today’s pressing issues, such as Covid, than those which may have even larger consequences but where those consequences are not going to be felt until some time in the future. What psychological barriers might prevent asset managers from divesting from unsustainable assets, and investing in sustainable ones? The main barrier is perhaps that of inertia, or status quo bias. It is always easier, and more comfortable, to keep doing what has always been done. So, if there is any way of reframing to accentuate any existing sustainability components of existing offerings, and then to present this as a new focus, then this is the path of least resistance. Of course, this does nothing new to enhance sustainability more than was already being done, it merely rebrands. Interestingly though, the desire to stick to the status quo might in many cases actually increase divestment from unsustainable assets. This is because often the easiest way of continuing with status quo approaches is to simply cut out the worst offenders. The rest of the portfolio can then be managed exactly as before, with no need for new processes, approaches or additional effort to enhance engagement with the management of assets (sustainable or otherwise). Divesting may often be the easiest way of becoming more sustainable without doing anything particularly different. What can today’s green and sustainable finance professionals do to try and redress this? Be prepared to change. Firstly, try to align the measures you use for sustainability to those which genuinely account for all the externalities companies impose on society, and account fully for any natural and social capital used in delivering their profits. This will require genuine change in processes, data and portfolio construction to weigh the complex costs companies impose on sustainability and engage deeply with company management to improve on these measures . . . not just the easy route of divesting assets which superficially fit ‘non-sustainable’ labels. Secondly, it will be

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necessary to genuinely understand the preferences and values of the end investor, and then design new products and solutions targeted to specifically meet these preferences. As one example of this, many asset managers are merrily peddling the myth that investors can do all the sustainable good they want without any sacrifice of returns. By doing so, they can largely continue doing what they’ve always done, exclude a few assets from the portfolio, and paint the rest light green in their marketing. It is certainly true that many sustainable investments require no sacrifice in returns, and even that some may offer higher long-term returns precisely because they are sustainable (though we also need to consider the strong possibility of sustainability bubbles that result in lower future returns). However, this is by no means universally true: many of the investments that offer the best possibility of genuine sustainable impact are likely to require investors to take additional risk, or to sacrifice some liquidity or expected returns. Those sustainable investments that are also just good investments would be invested in anyway. They don’t need help, and they don’t contribute anything additional to sustainability. The argument that investors should only invest in sustainable investments insofar as they improve returns is little more than an excuse to keep doing what has always been done. Furthermore, the behavioural evidence tells us that a substantial proportion of investors are not only prepared to trade off financial outcomes for social impact, but even desire this. This shouldn’t be a surprise, frankly, since most people are prepared to accept returns of minus 100 per cent to do good through their philanthropic activities, and so for many giving up a little financial upside to do social good is a powerful way to reap financial and social returns. And these investors comprise the segment with the highest demand for sustainable investing. After all, no one can get a warm glow from doing good if it costs nothing. It is ironic that, in the desire to stick to the status quo, many asset managers are fundamentally failing to meet the preferences of their highest-demand customer group.

Key concepts In this chapter, we considered: ●●

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the role of investment within the wider financial system, and how investment impacts and is impacted by environmental and social sustainability factors; different investment approaches and products, their suitability for different types of investors and how they may support green and sustainable finance;

Responsible and sustainable investment ●● ●●

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the growth in responsible and sustainable investment, and the reasons for this; the differences and similarities between responsible and sustainable investing, ESG, impact investing and other related terms; different types of investment funds, and how these may support investment in green and sustainable finance; and the risks of greenwashing, and other challenges to the growth of responsible and sustainable investing.

Now go back through this chapter and make sure you fully understand each point.

Review In the context of green and sustainable finance, terms including ‘ethical investment’, ‘ESG investment’, ‘impact investment’, ‘responsible investment’, ‘SRI investment’, and ‘values-based investing’ are in common use. All describe investments and/or investment strategies designed to deliver and support positive environmental and social impacts (and/or avoid negative impacts) and to – usually – deliver financial returns. Whilst some terms are used interchangeably, there are important differences between them. For the purposes of this book and course, we generally refer to ‘responsible’ and/ or ‘sustainable’ investment. We define this as an active approach to investing and investment decision making involving a positive selection of investments that deliver positive environmental and social benefits and support the transition to a sustainable, low-carbon world, combined with reducing or eliminating investments in harmful sectors and firms. A key feature of this approach is its focus on identifying, measuring and reporting both the positive and negative environmental and social sustainability impacts of investments. Sustainable investment has grown rapidly in recent years. According to the Global Sustainable Investment Alliance, sustainable investment totalled $35.3 trillion in 2020, an increase of 15 per cent over the two-year period since 2018, and sustainable investment assets under management accounted for nearly 36 per cent of total global assets under management. There are now more than 4,500 investors who have joined the UN Principles for Responsible Banking (PRI), all of whom have committed to incorporating environmental, social and governance (ESG) factors into investment analysis and decision making. There are many interlinked factors that combine to drive the growth of sustainable investment. Three key drivers are: ●●

a greater understanding, appreciation and disclosure of climate risks, and a growing understanding of broader environmental and sustainability risks;

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the development of policy and regulation to support the net zero transition of financial services and the economy overall; and the growing body of evidence that the financial returns from sustainable investments at least match, and in some cases outperform, their traditional counterparts.

Other important factors include changing consumer and investor demographics, values and preferences. There are a wide range of sustainable investment strategies that investors and investment managers may adopt. Ranging across a spectrum from light to dark green, these include: ●●

Very light green: negative screening

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Light green: positive screening

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Green: active ESG investing

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Dark green: impact investing

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Very dark green: shareholder activism

In practice, many investors and investment managers combine elements of different strategies, or aspects of them, in their investment decision making and fund and portfolio construction. Active investment strategies (where decisions are made based on an analysis of companies and economic/market factors) and passive strategies (where investors track the performance of a chosen market or index) may be adopted, too. The former approach is more prevalent in sustainable investment, given the need to understand the environmental and social sustainability benefits and harms from investments, although passive investment is now increasing, rapidly supported by the growth in ESG and similar indices. Equity markets have traditionally been the largest source of risk capital for companies in developed markets. This role has shifted and been challenged in recent years, but equity markets remain hugely important, both as sources of capital and in providing a vital role in terms of corporate governance and stewardship relating to company strategy, performance, capital allocation and – more recently – environmental and social sustainability. Large institutional shareholders, in particular, play a critical role as stewards of the companies in which they invest. They can – and do – have significant influence in ensuring that those companies prioritize environmental and social sustainability. A wide range of funds, products and services are available to support sustainable investment; we examined these in detail in this chapter. They include: ●●

listed equities

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equity indices

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unit and investment trusts

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index funds

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exchange-traded funds (ETFs)

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hedge funds

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private equity, venture capital and angel investing

It can be difficult for investors to assess, track and compare the environmental and other sustainability impacts of individual investments, portfolios and funds. Increased levels of transparency and disclosure, driven by investor pressure and regulation, are improving the situation. The lack of common definitions and metrics relating to sustainability factors still makes comparisons between different funds hard, however, especially across jurisdictions. There are a growing range of data analytics and technology tools that investors can use to better understand the sustainability credentials of investments and funds. In addition, labelling schemes that certify that a fund has met a minimum agreed standard relating to environmental and/or social sustainability performance are also available. There are further significant challenges to the continued growth of sustainable investment. These include greenwashing, the concept of fiduciary duty and shorttermism. Greenwashing, in particular, can damage investor confidence and market integrity. The rapid growth of the sustainable investment sector increases the incentives for deliberate greenwashing, and the probability of inadvertent greenwashing. Preventing and detecting greenwashing is a major focus for many regulators. The concept of fiduciary duty is evolving to incorporate sustainability factors into investment analysis and decision making; this should also help overcome some of the issues caused by short-term investment horizons and incentives. Table 9.1  Key terms Term

Definition

Active investing

Where investors make decisions based on their analysis of companies and economic/market factors, usually seeking an above-average return.

Angel investing

A type of very early-stage venture capital investing where (usually) wealthy individuals invest financially and offer advice, expertise and contacts to entrepreneurs.

Equity

An ownership share in a business, sold to individual or institutional investors who provide capital in return for a share of profits.

ESG investing

An investment approach that integrates Environmental, Social and Governance factors into investment analysis and decision making.

Ethical investing

A catch-all term generally used to describe investments, or investment approaches and strategies, based on investors’ or investment managers’ ethical and philosophical beliefs. (continued)

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Table 9.1  (Continued) Term

Definition

Exchange Traded Fund (ETF)

Similar to an Index Fund, except that a wider range of investment assets are used to deliver a risk/return profile similar to a market or similar index beyond the underlying assets themselves. ETFs can also be traded on stock exchanges.

Fiduciary duty

A legal concept common requiring agents to act in the best interests of the individuals or organizations they are acting for, using due skill, care and diligence.

Fund labelling

A ‘badge’, based on a certification scheme, that verifies that an investment fund has met minimum agreed standards (for example, relating to environmental and/or social sustainability performance).

Hedge fund

Funds for professional investors that seek to outperform the market, with investment managers adopting a very wide range of investment strategies and able to invest in almost any asset class.

Impact investing

An approach to investing that aims to achieve specific, measurable environmental and/or social objectives alongside financial returns.

Index

A selection of assets with similar characteristics, such as size, geographic focus, sector or impact/purpose, that provides a benchmark against which investors can compare the performance of the assets they hold.

Index fund

A popular type of passive investment fund, where the fund’s portfolio tracks and holds the components of a market index (for example, the FTSE 100).

Institutional investors

Professional investors investing on their own behalf, and/or pooling funds from a large number of individuals or other entities and investing on their behalf.

Investment fund

A selection of a (usually) diversified range of assets to deliver a risk/ return profile that matches investors’ characteristics, preferences and requirements.

Investment trust

A closed-ended investment fund that raises a fixed amount of capital from investors.

Listed equities

Shares listed on stock exchanges and traded on public markets.

Negative screening

The exclusion of certain assets, companies or sectors from an investment portfolio in line with pre-defined criteria.

Passive investing

Where investors track the performance of a chosen market or index, seeking to achieve an average market return through a diversified portfolio.

Positive screening The inclusion of assets, companies or sectors within an investment portfolio that meet pre-defined criteria. (continued)

Responsible and sustainable investment

Table 9.1  (Continued) Term

Definition

Principles for Responsible Investing (PRI)

Launched in 2006, the Principles for Responsible Investing were developed by the UNEP Finance Initiative and the UN Global Compact with the goal of working with investors to support a more sustainable global financial system. As of January 2021, the PRI have more than 3,000 signatories, representing $103.4 trillion in assets under management.

Private equity

Investments in assets that are not listed or traded on public markets.

Responsible investing

An approach to investment decision making informed by and aligned with the UN Principles for Responsible Investment (PRI). Responsible investing encompasses an active approach to incorporating ESG factors into investment decision making, strategies and engagement with investors and investees.

Retail investors

Non-professional investors investing their savings.

Shareholder activist

A person or entity who seeks to influence change in a company by exercising (or threatening to exercise) their voting rights.

SRI investing

Socially responsible investing, where investments are selected or eliminated in accordance with ethical guidelines and SRI ‘screens’ determined by the investor or investment manager.

Sustainable investing

An active approach to investing and investment decision making, involving the positive selection of investments that deliver environmental and social benefits and support the transition to a sustainable, low-carbon world, combined with reducing or eliminating investments in harmful sectors and firms.

Unit trust

An open-ended investment fund made up of units that are created by the fund manager when investors want to buy, and then cancelled/redeemed when they want to sell.

Values-based investing

An approach to investing that takes into account investors’ beliefs, preferences and values alongside their desire for a financial return.

Venture capital

A specific type of private equity investing with greater emphasis on investing in and developing new or early-stage businesses.

Notes 1 Simply Ethical (2022) Home, https://simplyethical.com (archived at https://perma.cc/​ 2CWD-A7GV) 2 Principles for Responsible Investment (2019) About the PRI, https://www.unpri.org/aboutus/about-the-pri (archived at https://perma.cc/DTT9-6UWV) 3 Global Impact Investing Network (GIIN) (2022) Home, https://thegiin.org (archived at https://perma.cc/E7C7-CACG)

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Green and Sustainable Finance 4 Impact Investing Institute (2022) Home, https://www.impactinvest.org.uk (archived at https://perma.cc/4T2E-6958) 5 IOSCO (2021) Environmental, Social and Governance (ESG): Ratings and data products providers final report, https://www.iosco.org/library/pubdocs/pdf/IOSCOPD690.pdf (archived at https://perma.cc/TW29-C7J4) 6 European Commission (2022) Sustainability-related disclosure in the financial services sector, https://ec.europa.eu/info/business-economy-euro/banking-and-finance/sustainablefinance/sustainability-related-disclosure-financial-services-sector_en (archived at https:// perma.cc/8GBM-X58Z) 7 Iris+ (2019) Documents: Iris+ Core Metrics Sets, https://iris.thegiin.org/document/iriscore-metrics-sets/ (archived at https://perma.cc/4DSG-JPLZ) 8 Impact Investing Institute (2022) Impact measurement, management and reporting, https://www.impactinvest.org.uk/modules/impact-measurement-management-and-report​ ing/ (archived at https://perma.cc/TM32-ZCEY) 9 Climate Action 100+ (2022) Home, http://www.climateaction100.org/ (archived at https://perma.cc/P4JT-2SST) 10 Engine No.1 (2021), Reenergize ExxonMobil // Investor Presentation, https://reener​ gizexom.com/materials/shareholder-materials/ (archived at https://perma.cc/6SEX-EXX8) 11 Ibid ­12 Hannah Duncan: Interview with James Purcell for the 2021 Chartered Banker Institute edition of this book 13 UNEP (2020) Are We Building Back Better? Evidence from 2020 and Pathways for Inclusive Green Recovery Spending, https://www.unep.org/resources/publication/are-webuilding-back-better-evidence-2020-and-pathways-inclusive-green (archived at https:// perma.cc/NVC9-C7QL) 14 CFA Institute (2020) Future of sustainability in investment management: From ideas to reality, https://www.cfainstitute.org/en/research/survey-reports/future-of-sustainability (archived at https://perma.cc/R544-55RJ) 15 Global Sustainable Investment Alliance (2021) Global Sustainable Investment Review 2020, http://www.gsi-alliance.org/wp-content/uploads/2021/07/GSIR-2020.pdf 16 Smith, O (2021) Sustainable assets are teetering on the $4 trillion mark, Morningstar, https://www.morningstar.co.uk/uk/news/216474/sustainable-assets-are-teetering-on-the%244-trillion-mark.aspx (archived at https://perma.cc/84GX-SXXL) 17 Morgan Stanley Institute for Sustainable Investing (2019) Sustainable signals: The individual investor perspective, https://www.morganstanley.com/pub/content/dam/msdotcom/ infographics/sustainable-investing/Sustainable_Signals_Individual_Investor_White_ Paper_Final.pdf (archived at https://perma.cc/4DVU-NMG3) 18 Cambridge Associates (2020) Sustainable and Impact Investing: Insights and perspectives, https://www.cambridgeassociates.com/wp-content/uploads/2020/11/ Sustainable-Impact-Investing-Survey-2020.pdf (archived at https://perma.cc/S2A9-CB4R) 19 Principles for Responsible Investment (2021) Annual Report, https://www.unpri.org/ annual-report-2021/delivering-our-blueprint-for-responsible-investment/responsibleinvestors/support-investors-incorporating-esg-issues (archived at https://perma. cc/29AG-QX2T)

Responsible and sustainable investment 20 UNEP FI (2018) 400 investors launch joint global investor agenda for climate action, https://www.unepfi.org/news/industries/investment/nearly-400-investors-with-32-trillionin-assets-step-up-action-on-climate-change/ (archived at https://perma.cc/KTG4-AAVJ) 21 Investor Agenda (2022) About us, https://theinvestoragenda.org/about-the-agenda/ (archived at https://perma.cc/V6AH-DQRT) 22 Economist Intelligence Unit (2015) The cost of inaction: recognizing the value at risk from climate change, https://eiuperspectives.economist.com/sustainability/cost-inaction (archived at https://perma.cc/C5XB-9NLN) 23 Cambridge Institute for Sustainability Leadership (2015) Unhedgeable risk: How climate change sentiment impacts investment, https://www.cisl.cam.ac.uk/news/blog/ unhedgeable​-risk (archived at https://perma.cc/JMQ5-KDS3) 24 Morgan Stanley (2021) Sustainable Reality: 2020 Update, https://www.morganstanley. com/content/dam/msdotcom/en/assets/pdfs/3190436-20-09-15_Sustainable-Reality2020-update_Final-Revised.pdf (archived at https://perma.cc/3DPC-YY6W) ­25 European Commission (2022) Sustainability-related disclosure in the financial service sector, https://ec.europa.eu/info/business-economy-euro/banking-and-finance/sustainablefinance/sustainability-related-disclosure-financial-services-sector_en (archived at https:// perma.cc/8GBM-X58Z) 26 So, R (2022) Preparing Mifid II Sustainability Preference Regulation, https://www.esgspecialist.com/preparing-for-mifid-ii-sustainability-preference-regulations/ (archived at https://perma.cc/BG4Y-RS9R) 27 BaFin: Federal Financial Supervisory Authority (2021) Preventing Greenwashing, https:// www.bafin.de/SharedDocs/Veroeffentlichungen/EN/Fachartikel/2021/fa_bj_2108_ Greenwashing_en.html (archived at https://perma.cc/EQV2-JNYY) 28 AMF (2022) Our priorities for action and supervision, https://www.amf-france.org/ en/amf/our-strategy/priorities-action-and-supervision (archived at https://perma.cc/ UN32-V3HZ) 29 US Securities Exchange Commission (2022) SEC proposes rules to enhance and standardize climate-related disclosures for investors, https://www.sec.gov/news/pressrelease/2022-46 (archived at https://perma.cc/U2AA-PNJK) 30 Financial Conduct Authority (2021) Guiding principles on design, delivery and disclosure of ESG and sustainable investment funds, https://www.fca.org.uk/news/news-stories/ guiding-principles-on-design-delivery-disclosure-esg-sustainable-investment-funds (archived at https://perma.cc/22TK-ACYM) 31 Deutsche Asset & Wealth Management (2015) ESG & corporate financial performance: Mapping the global landscape, https://www.unepfi.org/fileadmin/events/2018/ sydney/ESG-and-Corporate-Financial-Performance.pdf (archived at https://perma.cc/ AL8L-R5JC) 32 Khan, M, Serafeim, G and Yoon, A (2016) Corporate Sustainability: First evidence on materiality, The Accounting Review, 91 (6), pp 1697–724, https://papers.ssrn.com/sol3/ papers.cfm?abstract_id=2575912 (archived at https://perma.cc/D2F5-J45X) 33 Berchicci, L and King, A (2021) Corporate sustainability: A model uncertainty analysis of materiality, SSRN, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3848664 (archived at https://perma.cc/YP3Q-RF32)

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Green and Sustainable Finance 34 Deutsche Bank Research (2019) Climate change and corporates: Past the tipping point with customers and stockmarkets, https://flow.db.com/cash-management/past-thetipping-point (archived at https://perma.cc/ZS6W-VM27) 35 Bioy, H (2020) Do sustainable funds beat their rivals? Morningstar, www.morningstar. co.uk/uk/news/203214/do-sustainable-funds-beat-their-rivals.aspx (archived at https:// perma.cc/7UH6-RDQZ) 36 Fidelity (2020) Why sustainable investing does not mean lower returns, www.fidelity.ca/ en/investor/investorinsights/sustainable­investingdoesnotmeanlowerreturn/ (archived at https://perma.cc/5VHR-LHYG) 37 Morgan Stanley (2020) Sustainable Reality: 2020 Update, https://www.morganstanley. com/content/dam/msdotcom/en/assets/pdfs/3190436-20-09-15_Sustainable-Reality2020-update_Final-Revised.pdf (archived at https://perma.cc/3DPC-YY6W) 38 ESMA (2022) ESMA Annual Statistical Report on Performance and Costs of EU Retail Investment Products, https://www.esma.europa.eu/sites/default/files/library/esma_50-1651677_asr_performance_and_costs_of_eu_retail_investment_products.pdf (archived at https://perma.cc/C5LV-EHZX) 39 Hildebrand, P and Wiedman, M (2022) Managing the net-zero transition: the journey to net-zero carbon emissions is unfolding now – and offers extraordinary investment risks and opportunities, BlackRock, https://www.blackrock.com/corporate/literature/whitepa​ per/bii-managing-the-net-zero-transition-february-2022.pdf (archived at https://perma.cc/ DTL3-WRHF) 40 Schroders (2020) Institutional Investor Study 2020, https://www.schroders.com/en/us/ institutional/insights/institutional-investor-study-2020/sustainability/ (archived at https:// perma.cc/4VSY-DJKM) 41 Morgan Stanley Institute for Sustainable Investment (2017) Sustainable signals: Individual investor perspective, https://www.morganstanley.com/pub/content/dam/ msdotcom/infographics/sustainable-investing/Sustainable_Signals_Individual_Investor_ White_Paper_Final.pdf (archived at https://perma.cc/4DVU-NMG3) 42 Bank of Montreal Wealth Institute (2015) Financial concerns of women, https://www. bmo.com/privatebank/pdf/Q1-2015-Wealth-Institute-Report-Financial-Concerns-ofWomen.pdf (archived at https://perma.cc/7ZQQ-S8SK) 43 Moxie Future (2018) Understanding women’s preferences, perceptions and motivations on responsible investment, https://moxiefuture.com/understanding-female-investorsreport/ (archived at https://perma.cc/BDB4-957M) 44 Alladi, A and Dibenedetto, G (2021) The percentage of U.S. fund managers is exactly where it was in 2000, Morningstar, https://www.morningstar.com/articles/1029482/ the-percentage-of-us-female-fund-managers-is-exactly-where-it-was-in-2000 (archived at https://perma.cc/BSB5-W5N2) 45 CityWire (2020) Alpha Female 2020, https://citywireselector.com/news/alpha-female2020-parity-for-female-pms-is-almost-200-years-away/a1400250 (archived at https:// perma.cc/W6FQ-R4R4) 46 Kachaner, N et al (2020) The pandemic is heightening environmental awareness, BCG, https:// www.bcg.com/en-gb/publications/2020/pandemic-is-heightening-environmental-awareness (archived at https://perma.cc/569Q-NHAW)

Responsible and sustainable investment 47 Make My Money Matter (2022) Home, https://makemymoneymatter.co.uk/ (archived at https://perma.cc/AN47-2VTA) 48 Ethical Finance Hub (2020) Make My Money Matter, https://www.ethicalfinancehub. org/2020/06/30/make-my-money-matter/ (archived at https://perma.cc/9VDE-KPK3) 49 EcoAct (2020) The 10th Annual Sustainability Reporting Performance of the FTSE 100 | 2020, https://info.eco-act.com/en/sustainability-reporting-performance-ftse-100-2020 (archived at https://perma.cc/335S-WVXM) ­50 Jolly, J (2021) A third of top UK firms’ CO2 emissions not in line with global climate goals, Guardian, https://www.theguardian.com/environment/2021/mar/01/a-third-of-topuk-firms-emit-enough-co2-to-push-up-global-warming-by-27c (archived at https://perma. cc/7FM7-GGER) 51 Climate Risk Disclosure (2021) A tale of two share issues: How fossil fuel equity offerings are losing investors billions, https://carbontracker.org/reports/a-tale-of-twoshare-issues/ (archived at https://perma.cc/W2K4-4HNJ) 52 Kjellberg, S, Pradhan, T and Kuh, T (2019) An Evolution in ESG Indexing, https://www. chinaesg-pa2f.com/upload/file/20210313/20210313211157575757.pdf (archived at https://perma.cc/C2RS-6V29) 53 Inderst, G et al (2012) Defining and measuring green investments: Implications for institutional investors’ asset allocations, OECD Working Papers on Finance, Insurance and Private Pensions No. 24, https://www.oecd.org/environment/WP_24_Defining_and_ Measuring_Green_Investments.pdf (archived at https://perma.cc/FGJ3-PBF5) 54 FTSE Russell (2022) FTSE TPI Climate Transition Index Series, https://www.ftserussell. com/products/indices/tpi-climate-transition (archived at https://perma.cc/N6AF-YDAQ) 55 MSCI (2022) Climate Change Indexes, https://www.msci.com/climate-change-indexes (archived at https://perma.cc/7XLM-HY7W) 56 Ibid 57 Bloomberg Intelligence (2021) ESG assets may hit $53 trillion by 2025, a third of global AUM, https://www.bloomberg.com/professional/blog/esg-assets-may-hit-53-trillion-by2025-a-third-of-global-aum/ (archived at https://perma.cc/8RX9-BE3D) 58 Cheek, S (2021) Fund buyers wary as number of funds repurposed as ESG continues to rise, Portfolio Adviser, https://portfolio-adviser.com/fund-buyers-wary-as-numberof-funds-repurposed-as-esg-continues-to-rise/#:~:text=According%20to%20 Morningstar%20data%20published,from%20179%20the%20year%20before (archived at https://perma.cc/4Y7E-V2J4) 59 Bioy, H (2021) European Sustainable Funds Landscape: 2020 in Review, www. morningstar.com/en-uk/lp/sustainable-funds-landscape (archived at https://perma. cc/8XYN-BT7F) 60 Morningstar (2022) U.S. Sustainable Funds Landscape Report, https://www.morningstar. com/lp/sustainable-funds-landscape-report (archived at https://perma.cc/458P-4CT2) 61 Vanguard (2019) Vanguard’s first actively managed ESG fund now available for investment, https://corporate.vanguard.com/content/corporatesite/us/en/corp/who-weare/pressroom/first-actively-managed-esg-fund-available.html (archived at https://perma. cc/GZ7S-9WPT)

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Green and Sustainable Finance 62 CDP (2022) Climetrics: The climate rating for funds, https://www.cdp.net/en/investor/ climetrics/ (archived at https://perma.cc/UL85-XQTD) ­63 Morningstar: Sustainalytics (2022) ESG Risk Ratings: A consistent approach to assess material ESG risk, https://www.sustainalytics.com/esg-data (archived at https://perma. cc/3WFV-7J6M) 64 Tumelo (2022) Home: Business, https://www.tumelo.com/business (archived at https:// perma.cc/X92Q-UV8P) 65 Inyova (2022) Impact Investing Switzerland, https://inyova.ch/en/ (archived at https:// perma.cc/6QRB-JBTN) 66 Climetrics (2020) Climetrics: The climate rating for funds, https://www.cdp.net/en/ investor/climet​rics/ (archived at https://perma.cc/UL85-XQTD) 67 Husson-Traore, A, Moretti, L and Redon, N (2021) Overview of European Sustainable Finance Labels, https://www.novethic.com/fileadmin/user_upload/tx_ausynovethicetudes/ pdf_complets/Novethic_Overview-European-Sustainable-Finance-Labels_June_2020.pdf (archived at https://perma.cc/C3LL-A97S) 68 European Commission (2022) EU Labels for Benchmarks (Climate, ESG) and Benchmarks’ ESG Disclosures, https://ec.europa.eu/info/business-economy-euro/ banking-and-finance/sustainable-finance/eu-climate-benchmarks-and-benchmarks-esgdisclosures_en (archived at https://perma.cc/8D7P-2DER) 69 Dogra, G (2022) Global ETFs saw record inflows in 2021, https://www.reuters.com/ markets/europe/global-markets-etf-graphic-2022-01-21/ (archived at https://perma.cc/ W5XT-KVH4) 70 BlackRock (2022) 4 trends driving ETF growth, https://www.blackrock.com/hk/en/ ishares/insights/growth-trends (archived at https://perma.cc/V3JN-PT9P) 71 Boniface, A and Kyriakou, S (2021) How to choose an ESG exchange-traded fund, https://www.ftadviser.com/ftadviser-focus/2021/11/10/how-to-choose-an-esg-exchangetraded-fund/?page=1 (archived at https://perma.cc/6LDP-557V) 72 VettaFi (2022) Socially Responsible ETF list, https://etfdb.com/etfs/investment-style/ socially-responsible/ (archived at https://perma.cc/HQL9-KL67) 73 Financial Times (2016) Weather-tracker offers ray of sunshine for hedge funds, https:// www.ft.com/content/361457dc-2f38-11e6-a18d-a96ab29e3c95 (archived at https:// perma.cc/6G2N-EY8Z) 74 TheCityUK (nd) Green finance: A quantitative assessment of market trends, https:// www.thecityuk.com/our-work/green-finance-a-quantitative-assessment-of-market-trends/ (archived at https://perma.cc/ARE8-JF5Z) 75 Ibid 76 EnBW New Ventures (2022nd) Home, https://www.env.vc (archived at https://perma.cc/ MXC3-WF9Q) 77 Renault Nissan Mitsubishi (2022) Alliance Ventures, https://alliancernm.com/homealliance/alliance-ventures/ (archived at https://perma.cc/AQ3S-TTSU) 78 Ecosummit (nd) Home, http://ecosummit.net (archived at https://perma.cc/FN2Z-3M4H) 79 Green Angel Syndicate (nd) Home, www.greenangelsyndicate.com (archived at https:// perma.cc/RKG8-9D56)

Responsible and sustainable investment ­80 Schroders (2021) Sustainability: Institutional Investor Study 2021, https://www. schroders.com/en/sysglobalassets/digital/institutional-investor-study-2021/assets/ SIIS_2021_Sustainability.pdf (archived at https://perma.cc/G3XE-LMMY) 81 The Economist (2021) Sustainable finance is rife with greenwash. Time for more disclosure, https://www.economist.com/leaders/2021/05/22/sustainable-finance-is-rifewith-greenwash-time-for-more-disclosure (archived at https://perma.cc/HJ4H-VG59) 82 Castlefield (2020) Winners & Spinners: Thoughtful Investing Report 2020, https://www. castlefield.com/media/3074/castlefield_winnersspinners_report_2020_rs.pdf (archived at https://perma.cc/G3KX-3KDA) 83 Elliot, R et al (2020) Fiduciary Duty in the 21st Century: Final Report, https://www. unpri.org/download?ac=11972 (archived at https://perma.cc/6Q42-L6EL) 84 European Commission (2021) Strategy for Financing the Transition to a Sustainable Economy, https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52021DC0390 (archived at https://perma.cc/AK9N-WC3A) 85 Hannah Duncan: Interview with Greg Davies for the 2021 Chartered Banker Institute edition of this book

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Insurance – impact underwriting Introduction With core competencies in risk management and investment, the insurance sector is well positioned to embed climate, environmental and broader sustainability risks into decision making. Many insurers – particularly life insurers as long-term institutional investors – focus on managing climate risks and identifying opportunities in their investment portfolios. Others, especially general insurers, seek to directly address the causes and effects of climate change through impact underwriting, incentivising policyholders to adopt more sustainable behaviours and enhancing climate resilience. Climate risk insurance products such as sovereign catastrophe risk pooling and weather index insurance have been developed to improve the resilience of communities heavily impacted by climate change. Beyond environmental sustainability, products such as index insurance can also enhance social sustainability through greater financial inclusion.

L E A R N I N G OB J ECTI VES On completion of this chapter you will be able to: ●●

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Describe the role of insurance within the wider financial system, and how climate-related financial risks are impacting the insurance sector. Describe how different types of insurance activities, products and services can improve the quality and functioning of the natural environment and natural systems.

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Explain how impact underwriting can promote more environmentally and socially sustainable consumer behaviour. Cite examples and case studies of green and sustainable insurance products and services.

The role of insurance in the financial system The insurance industry’s core business is to understand, manage and carry risk. By pricing and creating a market, risk can be pooled, diversified, managed and mitigated so that individuals, households, businesses and communities are protected, which in turn supports economic development. When an individual or company takes out an insurance policy, they make regular payments – premiums – to an insurer in exchange for an agreement that the insurer will cover any losses that materialize under certain circumstances. Premiums are pooled with those of other policyholders and invested to pay for claims made by policyholders. Insurance companies – especially life ­insurers – are very significant institutional investors. Re-insurers help insurers diversify and mitigate the risks they face by providing insurance against major catastrophes. Without insurance, risks would be borne solely by individuals, households, businesses, communities and others. Insurance removes the fear of catastrophic losses and allows businesses and individuals to budget and plan without unexpected variations in expenses. When unexpected losses do arise, insurance helps those affected overcome the resultant financial hardship. According to UNEP FI, the insurance industry therefore has three key roles relevant to addressing climate risk and promoting sustainability:1 ●●

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Risk carrying: Insurance is a financial loss ‘shock absorber’ that reinforces the financial resilience of businesses and households to deal with unexpected losses, such as those resulting from natural disasters, currency fluctuations, policy shifts, illness or accident. This in turn enables investment and long-term planning. Risk management: The insurance sector’s contribution to managing risk extends beyond the losses it pays out, to identifying risks in the various areas and assets that can be insured. Insurers facilitate the understanding and reduction of risk through research, advocacy and support. Insurance pricing and other policy terms and conditions can provide clear risk signals and reward risk reduction efforts. Institutional investment: Insurance premiums are pooled and become part of a fund of financial assets that insurers invest to generate additional funds with which to meet their obligations to policyholders. Globally, it is estimated that the insurance industry has nearly $27 trillion in assets under management.

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QUICK QUESTIONS How might the insurance industry be affected by climate change and other forms of environmental damage? What risks and opportunities are there for the insurance industry?

The insurance sector and climate-related risks The costs of climate change According to the Sustainable Insurance Forum (SIF), the insurance sector has often led the financial services sector’s investigation of and responses to climate risk and other environmental issues. This is because of the sector’s immediate exposure to the physical risks and impacts involved, together with its advanced risk management expertise. The SIF notes that the sector’s risk transfer tools, together with its role as a long-term institutional investor, are highly relevant to aligning finance with the objectives of the Paris Agreement and wider goals such as the UN Sustainable Development Goals (SDGs).2 In Chapter 5, we learned that there are three main types of climate-related financial risks, following the classification system used by the Task Force on Climate-related Financial Disclosure (TCFD) and others: physical risks, transition risks and liability risks: ●●

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Physical risks: These arise from climate-related events, such as droughts, floods and storms. For insurers, in terms of their role as underwriters rather than institutional investors, the risks come from the impacts of such events, such as damage to property leading to claims from policyholders. In addition, claims from holders of business interruption and similar insurance may arise from disruptions in production or supply chains. Transition risks: These arise from the process of adjustment towards a lower-carbon economy, including developments in climate policy, new disruptive technologies or shifting consumer and investor sentiment. For insurance firms, transition risks mainly relate to the potential re-pricing of carbon-intensive financial assets, and the speed at which any such re-pricing might occur. This could lead to asset impairment or stranded assets impacting insurance companies as institutional investors. Liability risks: These arise from parties who have suffered loss or damage from the effects of climate change and who seek compensation from major emitters and their insurers via general and public liability, company directors’ and other forms of insurance. In addition, insurers (and other financial institutions) may face claims

Insurance – impact underwriting

for failing to adequately address climate change in the context of fiduciary duty and/or in the promotion and sales of financial products and services. As we saw in Chapter 5, NGOs and others are increasingly using litigation as a tool, increasing liability risks for businesses and their insurers. We saw in Chapter 2 that, according to the latest report from the IPCC (AR6), global warming will increase both the severity and frequency of weather-related natural disasters, thereby increasing the physical risks for insurers. The Issues Paper on Climate Risks to the Insurance Sector, published by the Sustainable Insurance Forum (SIF) and the International Association of Insurance Supervisors (IAIS) in July 2018, summarizes the strong scientific consensus that climate change is influencing the frequency and severity of extreme weather events such as droughts, storms, floods and wildfires, including: ●●

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research by the World Meteorological Organization concluding that 80 per cent of natural disasters between 2005 and 2015 were in some way climate-related; and an analysis of 59 studies in scientific journals published between 2016 and 2017 reporting that 70 per cent of these found that climate change has increased the risk of extreme weather events.3

Similar conclusions have been reached by other regulatory and insurance sector bodies. In its December 2021 Financial Stability Report, for example, the European Insurance and Occupational Pensions Authority (EIOPA) noted that environmental – especially climate – risks are the top material risks faced by insurers because of the increasing frequency and intensity of extreme weather events.4 According to MunichRE, 2021 was the second costliest year on record in terms of insured losses from natural disasters, mainly extreme weather-related events, with overall economic losses estimated at $280 billion – of which approximately $120  billion were insured losses. Hurricane Ida alone was estimated to have cost insurers some $36 billion. MunichRE notes that ‘Many of the weather catastrophes fit in with the expected consequences of climate change, making greater loss preparedness and climate protection a matter of urgency.’5 The difference between the total economic losses from a climate-related event (such as a tropical storm) or series of such events and the insured losses is known as the climate risk protection gap. 2017, though, was the most expensive year on record (to date) for insurance companies. Extreme weather events and other natural disasters, including Hurricanes Harvey, Irma and Maria, cost an estimated $330 billion in total economic losses, with insured losses estimated at $135 billion, meaning there was a sizeable climate risk protection gap. Many large global insurers posted significant losses for 2017, including Lloyd’s of London and Berkshire Hathaway. According to Aon Benfield as reported in the Insurance Journal, total economic losses in the United States from hurricanes in 2017 were nearly five times the average of the preceding 16 years,

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losses from wildfires were four times higher and losses from other severe storms some 60  per cent higher.6 Total economic losses from natural catastrophes in 2018 and 2019 were lower, but still very significant, estimated by Swiss Re as approximately $176 billion and $140 billion, respectively.7 Even if we succeed in limiting global warming to below 2°C, as the IPCC’s AR6 sets out, the frequency and severity of extreme weather events – and hence the associated physical risks and impacts – will increase. Climate and related environmental risks will continue to have an increasing financial impact on insurers and the global economy overall. Despite many insurers’ advanced risk management systems, and the growing appreciation and management of climate risks in particular, the impact of unforeseen physical risks (that is, even more frequent and more severe extreme weather events) may impose further significant costs on insurers. The increasing frequency and severity of extreme weather events is also likely to make increasing numbers of properties and businesses uninsurable, as heightened risk increases premiums to the point where they become unaffordable.

READING 2017 set to be among the most expensive on record after year of climate disasters, insurance leaders warn8 A climate risk protection gap of US$1.7 trillion caused by extreme weather over the past decade opens up many new opportunities for insurers, says ClimateWise. Natural disasters and extreme weather impacting every corner of the world mean 2017 is on track to become one of the most expensive on record, according to ClimateWise, a global network of insurance and industry organizations. Hurricane Harvey, which caused US$180 billion in losses when it hit Texas in August, was just one of the many events that exposed the growing climate risk protection gap and the urgent need to improve the resilience of cities. In particular, the devastation highlighted the pressing importance of insurance, with only one in five homeowners in Greater Houston having flood insurance, and insured losses amounting to less than US$19 billion – or just 10.5 per cent – of the total losses. In developing countries, insurance penetration is even lower, leaving countries highly vulnerable when floods, droughts or hurricanes strike, as seen in Bangladesh and India. ‘Our industry has been shaken by climate perils impacting urban centres, and 2017 is on track to become one of the most expensive years on record,’ said Maurice Tulloch, Chairman of Global General Insurance at Aviva and Chair of ClimateWise, the network convened by the University of Cambridge Institute for Sustainability

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Leadership (CISL). ClimateWise, which is committed to helping insurers and society respond to the risks of climate change, has published The ClimateWise Principles Independent Review 2017, an annual assessment of its members. ‘The climate risk protection gap presents insurers with one of our industry’s most profound challenges. The cost of extending sustainable insurance cover is now simply not affordable in many places. A proactive response is required.’ Throughout the past decade, just 30 per cent of catastrophic losses were insured, producing a cumulative shortfall of US$1.7 trillion, according to ClimateWise member Swiss Re. The majority of this shortfall was borne by government and civil society. With 50 per cent of the world’s population now living in cities, and 1.5 million people migrating to urban areas every week, improving resilience to climate-related disasters is more important than ever. ‘Cities are at the epicentre of the climate risk protection gap crisis, given their concentration of economic activity and vulnerability,’ said Tom Herbstein, ClimateWise Director. ‘The challenge is how to extend insurance cover in a world where climate risk exposure continues to grow. While the climate risk protection gap presents a very real challenge for cities, there are also many opportunities for new partnerships and products. Insurers must start proactively exploring where, within their own value chains, and collaboratively across the industry, these opportunities lie.’

As major institutional investors, insurers are a key source of long-term finance (sometimes referred to as ‘patient capital’) for firms, sectors and technologies seeking to decarbonize and develop climate-resilient infrastructure. Swiss Re, for example, estimates ‘an annual US$920 billion opportunity for long-term investors over the next 20 years’ in emerging markets and expects that ‘[infrastructure] projects can deliver attractive yields to help insurers match their long-term liabilities, while also offering region and asset-class diversification, and opportunity for environmentally and socially responsible investing.’9 BlackRock’s 2021 Global Insurance Report found that the great majority (95 per cent) of senior insurance executives believed climate risk would have a significant impact on how their firms constructed their investment portfolios. Half of the executives surveyed reported that more sustainable portfolios would generate better risk-adjusted performance, and a similar proportion stated they had turned down an investment opportunity due to ESG concerns.10 There are some significant barriers and obstacles that need to be removed, however, before insurers can unlock the full potential of their financial capacity as investors in environmentally sustainable infrastructure and other long-term, sustainable assets. These include complex regulatory restrictions, especially relating to capital requirements, and a lack of availability of investment opportunities of the scale required.

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Insurance regulation and climate change There is no single, global insurance regulator, although national regulators are brought together through bodies such as the Network for Greening the Financial System (examined in previous chapters; in some countries, insurers as major financial institutions are overseen by central banks in respect of prudential requirements) and the International Association of Insurance Supervisors (IAIS), briefly introduced above. As is the case in banking and investment, in recent years insurance regulators have taken greater interest in climate risks, from a financial stability perspective, with the European Union playing a leading role. The Sustainable Insurance Forum (SIF) was launched in 2016 to promote cooperation on critical sustainable insurance challenges, such as climate change. It comprises an international network of insurance regulators and supervisors, and includes insurance supervisors and regulators from more than 20 countries including Australia, Brazil, France, Germany, Ghana, Jamaica, Morocco, the Netherlands, Singapore, the UK and the US, as well as the IAIS. In 2016, the European Union introduced a new, Europe-wide system for insurance regulation known as ‘Solvency II’. This sets out a risk-based, EU-wide approach to the assessment of capital adequacy, risk management and reporting for insurers. It follows a ‘three-pillar’ approach similar to Basel III for banks, described in earlier chapters: ●●

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Pillar 1: Defines the quantitative requirements for the amount of capital that insurers must hold. Pillar 2: Sets out the supervisory process to ensure that insurers hold sufficient capital against risks, and that risk governance and management systems are adequate. Pillar 3: Defines transparency and minimum disclosure obligations for insurers.

The Solvency II regime requires insurers to be capitalized to withstand losses of a one-in-200-year event, over a one-year time horizon. This was developed before climate risk became a priority for EU regulators, and some believe the approach is now insufficient. Some have called for a one-in-100-year approach, and others for the introduction of a green supporting factor or a brown penalty factor for Pillar 1 capital requirements for insurers to incentivize them to decarbonise their investment portfolios. In 2021, the European Commission proposed a series of reforms to Solvency II, including the potential introduction of a brown penalty factor. The European Insurance and Occupational Pension Authority (EIOPA) has been tasked with examining the evidence for and the potential impacts of this, to report in 2023. In addition, the Commission introduced a wider series of proposals designed to ensure greater identification and disclosure of climate-related and environmental risks, to support

Insurance – impact underwriting

the economic recovery from Covid-19 and to support the European Green Deal by releasing up to €90 billion for investment by insurers.11 In the US, building on the work of regulators in other jurisdictions, 2021 also saw regulators introduce new requirements and guidance for insurers relating to climate risks. The New York State Department of Financial Services (NYDFS), which supervises over 1,800 insurers with combined assets of $5.5 trillion, published final guidance on identifying, managing, and disclosing climate risks. The NYDFS expects insurers to take a strategic approach to managing climate risks that considers both current and forward-looking risks and identifies actions needed to manage those risks in a manner proportionate to the nature, scale and complexity of insurers’ businesses. Specifically, insurers should: ●● ●●

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integrate the consideration of climate risks into their governance structures; consider the current and forward-looking impact of climate-related risks using time horizons appropriately tailored to the insurer, its activities and the decisions being made; embed climate risks in existing financial risk management frameworks and analyse the impact of climate risks on existing risk factors; use scenario analysis to inform business strategies and risk assessment and identification; and disclose climate risks in line with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD).12

As described in Chapter 3, in March 2022 the US Securities and Exchange Commission proposed rule changes requiring firms to disclose climate-related financial risks in line with the TCFD’s recommendations, including disclosure of material financed (Scope 3) greenhouse gas emissions. This will encompass many major insurers to the extent that they are regulated by the SEC to access US capital markets. Together with the European Commission’s proposals, the continuing development of regulation in major capital markets should unlock and incentivize the decarbonization of insurers’ investment portfolios over time.

QUICK QUESTION What do insurance regulators in the market(s) you work in require in relation to capital requirements and disclosures relating to climate change?

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UN Principles for Sustainable Insurance and the Sustainable Insurance Forum With a strong interest as risk manager, risk carrier, underwriter and investor in identifying and mitigating the risks posed by climate change, the insurance profession has often taken the lead within the financial services sector on environmental sustainability issues. This has included promoting action to understand the potential impacts of climate change, conducting sophisticated climate modelling, data analysis and research, and developing new products and services to support sustainability. The insurance profession has also acted (and acts) collectively, and was a significant supporter of the establishment of the UN Environment Programme’s Finance Initiative (UNEP FI) in the late 1990s. In 2012, the UN Principles for Sustainable Insurance (UN PSI) were launched at the UN Conference on Sustainable Development. The UN PSI serve as a global framework for the insurance sector to address environmental, social and governance risks and opportunities. Endorsed by the UN Secretary-General, the Principles have led to the largest collaborative initiative between the UN and the insurance sector. As of February 2021, over 140 organizations worldwide have adopted the Principles, including insurers representing more than 25 per cent of world premium volume and $14 trillion in assets under management. The Principles are part of the insurance sector’s criteria for inclusion in the Dow Jones Sustainability Indices and FTSE4Good.

THE PRINCIPLES FOR SUSTAINABLE INSURANCE 1 We will embed in our decision-making environmental, social and governance issues relevant to our insurance business. 2 We will work together with our clients and business partners to raise awareness of environmental, social and governance issues, manage risk and develop solutions. 3 We will work together with governments, regulators and other key stakeholders to promote widespread action across society on environmental, social and governance issues. 4 We will demonstrate accountability and transparency in regularly disclosing publicly our progress in implementing the Principles.13

Insurance – impact underwriting

The UN PSI provide a forum for insurers to develop frameworks, standards, guidance and tools to promote a sustainable approach to insurance and share best practice. In November 2018, UNEP FI, together with 22 large global insurers and reinsurers, announced a partnership to develop a new generation of climate risk assessment tools that insurers could use to identify, disclose and manage climate risks in line with the TCFD’s recommendations. Insuring the Climate Transition: Enhancing the insurance industry’s assessment of climate change futures was published in 2021, and examines physical, transition and liability risks in insurance underwriting portfolios, with a focus on scenario analysis, the growing importance of liability risks and how these are interlinked with physical and transition risks. It also looks at opportunities for the insurance sector, from developing new products and services to helping clients assess and manage risk and improve their resilience to climate risks.14 We look at some examples of these later in this chapter. Insurance regulators have also been proactive in promoting environmental sustainability and a more comprehensive approach to climate risk. The Sustainable Insurance Forum (SIF), mentioned above, was launched in 2016 to promote cooperation on critical sustainable insurance challenges, such as climate change. Convened by UNEP FI, the SIF is an international network of insurance regulators and supervisors. Its 30 members cover more than 90 per cent of the global insurance market. The SIF is very focused on climate risks, and in May 2021, in conjunction with the International Association of Insurance Supervisors (IAIS) it published a paper for its members on the regulation of climate risks. The SIF/IAIS Application Paper on the Supervision of Climate-related Risks in the Insurance Sector aims to provide regulators with guidance on integrating climate risk into their supervisory activities. It covers areas including corporate governance, risk management, investments, public disclosures and regulatory reporting.15 By providing guidance, the SIF and IAIS aim to encourage greater coordination and harmonization of regulatory approaches, as we have discussed in earlier chapters.

Promoting sustainability through insurance – impact underwriting Whilst many insurers continue to focus on enhancing their climate-related financial risk management in order to better price premiums and manage their investment portfolios, others are developing new products and services designed to help mitigate the effects of climate change and promote sustainability more broadly. The types of products that insurance firms offer vary according to the type of insurance services they provide. Broadly, there are three categories of insurance firm: ●●

Life insurers provide benefits in the event of death, retirement or changes in health, and also provide savings mechanisms for households. Products include annuities, conventional life assurance and other long-term savings products.

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General insurers (also known as non-life insurers or property and casualty insurers) provide non-life insurance, which includes property cover, health insurance, liability policies and miscellaneous financial loss cover for individuals, companies and others. Certain real economy activities require, either contractually or as a matter of public policy, insurance cover to be retained (for example, car insurance or employers’ liability). Reinsurers sell insurance to other insurance companies. They enable the primary insurance companies described above to cede a portion of risks they do not want to retain. Reinsurers pursue similar business models to primary insurers, albeit pooling a more diverse set of risks.

Life insurers tend to be more affected by risks from their investments on the asset side of their balance sheets, as they need to match assets to liabilities over the longer term, and because their liabilities tend to be less volatile. They rely on investment returns to fulfil their longer-term obligations on their savings, pension and annuity liabilities. As such, the main way in which life insurers can promote sustainability is through their investment portfolios. We have already considered the role of institutional investors in bond and equity markets in previous chapters. General insurers tend to face more risks from their liabilities than their assets, which are often shorter in duration, predominantly from annual contracts of insurance. As such, an important way that general insurers can promote sustainability and mitigate the impact of climate change is by offering new green and sustainable products and services that may encourage changes in individual or corporate behaviour, referred to as ‘impact underwriting’. General insurance products and services are generally split into two categories: personal insurance, where the policyholder is a private individual, and commercial insurance, where the policyholder is a firm or some other kind of organization. New products have emerged in both categories to assist with the transition to a sustainable, low-carbon world, as we go on to describe below.

Environmental, climate and green insurance Although ‘environmental’, ‘climate’ and ‘green’ insurance may sound similar, they are in fact quite different. Environmental insurance provides protection from actual/ potential liabilities arising from environmental damage; for example, coverage to protect against pollution, oil spills or other forms of environmental damage. Climate insurance (also known as climate risk insurance) provides protection against (usually) extreme weather events such as drought, floods and storms. We look at this in more detail below. Green insurance, by contrast, seeks to encourage and support sustainable activities and behaviour by individuals, companies and others. It includes green insurance products and services that allow an insurance premium differentiation on the basis

Insurance – impact underwriting

of environmentally relevant characteristics/behaviour, and products and services that are tailored for promoting ‘green’ activities, such as the use of renewable energy or other carbon-reducing activities. This is increasingly referred to as ‘impact underwriting’ – insurance products and services that incentivize policyholders to adopt more sustainable behaviour, contributing to climate mitigation and/or adaptation efforts.

QUICK QUESTION Can you think of any insurance products or services that might fit with our definition of green insurance/impact underwriting? Do you hold any of these?

Impact underwriting: personal insurance Personal insurance helps protect individuals from potential losses they could not afford to cover on their own. Insurance enables people to, for example, drive a car and own a home without risking major financial loss, and encourages individuals to save and invest for the future.

Motor insurance Road transport is a significant component of the modern economy. There are some one billion vehicles on the road worldwide, generating approximately 17 per cent of man-made greenhouse gases (GHGs). It is generally mandatory for drivers to have third-party liability insurance. There are several ways in which motor insurers can enhance environmental sustainability through impact underwriting. One way is through offering discounts for environmentally friendly vehicles. Some motor insurance companies offer lower premiums for those who drive hybrid vehicles. A similar discount may also apply to hybrid-electric boats and yachts, or cars that use alternative energy sources, such as natural gas, hydrogen or ethanol. Some motor policies include an option of adding an endorsement to upgrade to a hybrid vehicle after the loss of the current vehicle. In some cases, insurers may seek to mitigate climate change by offsetting some or all of the CO2 produced by the insured vehicle. Co-Op Insurance in the UK, for example, offsets 10 per cent of the car’s emissions during the first year of the policy (and offers a similar scheme for home insurance, too), using part of the premium charged to all policyholders. The funds are used to support climate change mitigation and/or adaptation projects. Specific electric vehicle insurance has also been developed, with discounts for purchasers, although given the relatively high costs of fully electric vehicles,

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premiums may still be high when compared with petrol or diesel alternatives. There are additional features that insurers in some countries need to consider when designing insurance policies for electric vehicles, including whether the electric battery is owned, or leased separately from the vehicle itself (which is the case for a minority of vehicles), as well as the need for public liability insurance in the event of an accident involving the charger cable. Some insurers, as in the case study below, also offer recovery to an electric chargepoint if a vehicle runs out of electric power.

CASE STUDY LV= electric car insurance16 LV= is a brand name of British mutual insurer Liverpool Victoria, established in 1843. As a major motor insurer, it provides a wide range of policies to drivers, including electric car insurance with additional features to reflect ownership and use of electric vehicles. All electric car policies include: ●●

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Recovery to the nearest electric chargepoint (in the UK) if the vehicle runs out of charge. LV= also has a partnership with an electric vehicle charging assistance company, which helps if no chargepoint is nearby. Cover for electric charging cables, wall boxes and adaptors. Battery cover for accidental damage, fire and theft – even if the battery is leased separately from the car. Vehicle software updates are covered as standard.

In addition, policyholders can pay an additional premium for hire car cover, which will replace their electric vehicle with an electric or hybrid hire car during periods of repair.

Another way that motor insurers can seek to promote more sustainable vehicle usage is through ‘Usage-Based Insurance’ (UBI), of which there are two basic types: ●●

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Pay How You Drive (PHYD), where the insurance premium is based on how a vehicle is driven, taking into account factors including speed, acceleration and braking. Pay As You Drive (PAYD), where the premium is typically calculated based on the distance driven, and perhaps also the type and length of average/typical journeys.

UBI is available to individuals and to organizations managing fleets of commercial vehicles (local government, public transport, logistics companies). In the UK,

Insurance – impact underwriting

according to GlobalData, by 2019 nearly 10 per cent of drivers overall, and more than 20 per cent of younger drivers, had adopted UBI.17 Usage-based fleet insurance is predicted to grow more rapidly than personal car insurance in all major markets, as linking the cost of insurance to usage is especially attractive to companies with large fleets of commercial vehicles. In both PHYD and PAYD, devices or sensors embedded in vehicles, or smartphonebased apps, record telemetry tracking vehicle data such as acceleration, braking, distance, speed, journey time, the amount of time the engine is idling, fuel consumption and efficiency, and many more data points. Many insurers are now using smartphone-based systems as an easier (and cheaper) way to track vehicles and driving styles. They use GPS satellites to record usage rather than relying on ‘black boxes’ and sensors embedded in the vehicle. The telemetry recorded can then be analysed by the insurer to price driver premiums more accurately, based on distance driven (PAYD) and/or driving style (PHYD), with lower premiums available for more efficient and/or careful drivers. According to some estimates, UBI subscribers decrease their miles driven by 10 per cent or more, saving drivers money while reducing accidents, congestion and air pollution. UBI schemes are growing in popularity, not just because of their environmental benefits, but also because of the cheaper insurance available to individual drivers and fleet managers. According to a report by Ptolemus, a consulting firm, there were more than 20 million active UBI policies globally, with 372 active UBI schemes in 58 countries (2018).18 This is still only a small part of the overall motor insurance market, however, accounting for some $15 billion of premiums compared with $715 billion in total, so there is considerable room for growth. Frost & Sullivan estimates that the UBI market will grow to cover 100 million drivers by 2025, with significant growth in the US, Europe and China.19 Recent regulatory changes in China to enable UBI to be offered by insurers, combined with the high penetration of smartphones, means that the growth of UBI in the world’s largest automotive market is likely to be rapid.

QUICK QUESTION What would encourage you to switch to usage-based insurance, as a driver?

Home (domestic) insurance Residential and commercial buildings are estimated to account for over 12 per cent of global water use, 40 per cent of global CO2 emissions and more than 70 per cent of electricity consumption. Some insurers offer to offset some or all of the CO2 emissions

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from a policyholder’s home, although one of the best-known examples (Co-Op Insurance in the UK) only offsets 10 per cent of emissions during the first year of the policy. Others, such as Naturesave (see the following case study), offer discounts to policyholders who make energy efficiency improvements to their homes, incentivizing more sustainable lifestyle choices. More generally, there is growing recognition of the benefits of building green homes, or retrofitting existing properties to make them much more energy efficient. According to the US Green Building Council, green homes use up to 40 per cent less energy and up to 50 per cent less water than comparable standard homes. Moreover, the use of toxin-free building materials helps reduce indoor air pollution, which in some cases can be more harmful than outdoor air pollution. ‘Passive houses’, buildings designed without the need for heating and cooling systems, use a combination of positioning, natural ventilation and shading, efficient construction, roof and window design, insulation, and solar/other renewable energy to minimize heat loss (in colder climates) and maximize heat gains. Passive houses are estimated to reduce energy consumption by up to 90 per cent, according to the International Passive House Association (IPHA). In many countries, national building codes and standards have been or are being updated to encourage or require the building of more energy-efficient homes. The introduction of compulsory Energy Performance Certificates and the like also provides a mechanism for promoting energy-efficiency measures when buying, selling and renovating homes. Many national and local building codes are referenced to the International Green Construction Code (IgCC),20 which promotes a whole-system approach to the design, construction and operation of buildings, and sets out criteria in areas including energy efficiency, resource conservation, indoor environmental quality and building performance that are designed to improve sustainability. Insurers are helping promote green homes in a number of different ways. Some insurers offer lower premiums for homes that meet stringent efficiency and sustainability standards, often based on or linked to the IgCC or similar national codes. Others may offer discounts for properties that adopt ‘smart home’ products, such as smart water sensors that shut off water sources when leaks are detected. Other insurers offer products that cover rebuilding costs for damaged buildings and homes to upgrade them to meet better environmental standards, as well as insurance products that replace damaged appliances with energy-efficient ones. This is sometimes referred to as ‘green upgrade’ insurance. For homeowners who generate their own renewable energy and sell surplus energy back to the local power grid, there are now insurance policies that cover both the income lost when there is a power outage and the extra expense to the homeowner of temporarily buying electricity from another source.

Insurance – impact underwriting

CASE STUDY Naturesave Home Insurance21 Naturesave Insurance describes itself as ‘the UK’s leading ethical insurance provider’, offering home, travel, business and renewable energy insurance. Founded in 1993, two years later Naturesave established a charitable trust to provide grants for environmental projects, fund a tree planting scheme and provide advice for small businesses looking to become more sustainable. Ten per cent of all personal insurance premiums are donated to the Naturesave Trust to fund its activities. In addition, the insurer is a carbon-neutral organization, has a no-fly business travel policy, and encourages staff not to fly when taking their holidays. In its business strategy, activities and corporate culture, Naturesave ‘practices what it preaches’. To encourage policyholders to reduce emissions, Naturesave’s home insurance policies offer discounts for installing loft insulation, double glazing and energyefficient appliances. Policies also include cover for domestic renewable energy systems (such as heat pumps and solar panels) as standard – other insurers often charge an additional premium for these. Naturesave’s expertise also enables them to insure non-standard homes, such as passive houses, that other insurers would struggle to provide cover for at an affordable price. With sustainability embedded into its strategy, culture and insurance, Naturesave is a good example of impact underwriting in action.

Travel insurance Prior to the Covid-19 pandemic, air travel accounted for approximately 2.5 per cent of global GHG emissions, but travel fell by nearly 70 per cent in 2020, according to the International Air Transport Association (IATA). Predictions vary, but many believe it may not recover to pre-pandemic levels until 2025 at the earliest. As with motor and home insurance as discussed above, some travel insurers offer policyholders the chance to offset some or all of the CO2 emissions from (usually) their flights. Unlike the Co-Op car and home insurance examples, however, in many cases policyholders pay an extra fee to support climate change mitigation and/or adaptation projects rather than this coming from the premium paid by all policyholders. It may be argued, however, that unlike some of the examples of motor and home insurance above, green travel insurance cannot really be described as a form of impact underwriting because it does not incentivize policyholders to adopt more sustainable

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behaviour. In fact, it may achieve the opposite, by encouraging individuals to travel more because they believe offsetting fully compensates for the emissions they generate. From this perspective, it is hard to see how travel insurance can be considered ‘sustainable’ unless it directly incentivizes more environmentally sustainable forms of transport (for example, electric rail versus air travel).

Impact underwriting: commercial and corporate insurance Commercial and corporate insurance protects businesses and other organizations from potential losses they could not afford to cover on their own. This in turn allows businesses to operate when otherwise it might be too risky to do so. In this way, insurance supports entrepreneurialism, innovation and economic development by managing risks that could deter people from starting and growing businesses. In terms of climate-related and broader sustainability risks, insurance can cover a wide range of risks to which businesses are exposed, including, but by no means limited, to: ●●

catastrophic risks (for example, hurricanes and tropical storms);

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direct losses caused by extreme weather events (such as flooding);

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business and supply-chain interruption; and

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legal liabilities arising from environmental and other damage caused by an organization’s activities.

Policies for these and similar risks for organizations often tend to be underwritten on a bespoke basis, given that the exposure to and risk profile of climate, environmental and other sustainability risks will vary on a case-by-case basis. A policyholder’s location(s), business activities, supply chains and many other factors will impact the pricing of risk and insurance. As more organizations adopt the recommendations of the TCFD for identifying, disclosing and managing climate-related risks, and as additional guidance is developed to encourage standardized approaches to TCFD reporting for different industry sectors, we are likely to see the development of more standardized commercial insurance products and services in this area, too. In the following section, we focus mainly on green commercial insurance that encourages and supports sustainability by incentivizing the adoption of energy efficiency measures, and helps businesses manage the risks of investing in new, energyefficient technologies. Before we do, though, we present a short case study of an innovative example of a bespoke insurance product that promotes climate resilience.

Insurance – impact underwriting

CORAL REEF INSURANCE The World’s First Coral Reef Insurance Payout22 Coral reefs are one of the ecosystems most under threat from global warming, pollution and other impacts of human activities. Approximately 25 per cent of the world’s fish stocks are dependent on the health of coral reefs. Reefs also protect coastal areas and communities from storms and erosion and generate substantial economic activity from fishing and tourism. The Mesoamerican Reef is one example of an ecosystem under serious threat from climate change, including increasing sea temperatures, rising sea levels and the impact of more frequent and severe extreme weather events. Stretching nearly 1,000 km along the Caribbean coasts of Mexico, Belize, Guatemala and Honduras, it is the largest reef system in the Americas and home to a wide variety of marine life. It is estimated that Mesoamerican Reef currently supports some $6.2 billion per year of economic activity, but by 2030 this could fall by 50 per cent due to the bleaching and erosion of the reef. In October 2020, Hurricane Delta hit the coast of Quintana Roo, on Mexico’s Yucatan Peninsula, causing widespread damage to many ecosystems, including the Mesoamerican Reef. The regional government of Quintana Roo had insured this stretch of the reef, however, through bespoke reef insurance developed by Swiss Re and The Nature Conservancy (TNC). The policy paid out almost $800,000 to help fund the repair and restoration of the reef – the world’s first coral reef insurance payout. Swiss Re also provided assistance to train ‘Reef Brigades’ – teams of community members who are equipped to repair the reef after a storm.

Commercial property insurance Traditional commercial property insurance covers the replacement or repair of damaged property, using materials similar to those in the original construction, or basing repayment on the value of the original equipment or building. Insurers now offer green insurance products, which replace standard materials with environmentally friendly or more energy-efficient ones when repairs are made. In the event of a total loss, some policies may cover the costs of rebuilding as a ‘green’ building – in fact, this may be required in some countries and regions by national and local ­building codes.

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CASE STUDY Allianz Insurance Green Solutions23 Allianz is a large global insurer that has developed a wide range of ‘Green Solutions’ to support both retail and corporate customers. These aim both to help protect customers from climate and environmental risks and support climate change mitigation and adaptation. Different insurance products and services have been developed in different markets to meet the needs of commercial customers and clients, including: ●●

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Eco Upgrade: coverage for the increased cost of replacing damaged property and modernizing buildings to include environmentally friendly equipment, products and construction materials. Energy Performance Services: advisory services to reduce energy costs and CO2 emissions, as well as energy certification for buildings and heating and cooling systems. Renewable Energy Insurance: insurance for renewable energy projects including business interruption, liability or technical failure. Loss of Earnings: insurance against financial losses due to discrepancies in actual annual energy output compared to the expected output from renewable energy generation. Renewable Energy Advisory and Services: evaluation reports/assessments for renewable energy generators and supply chains, including process and product quality management, as well as the review of product certification, customers’ track records and project references.

Renewable energy insurance Renewable energy generation has increased dramatically in recent years, driven by government policy, changing customer attitudes and advances in technology. A wide range of insurance products has emerged, tailored towards the renewable energy market. They include coverage spanning construction and operational risks, business interruption, liability or technical failure, and loss of earnings due to discrepancies in actual versus expected energy generation.

Insurance – impact underwriting

CASE STUDY Renewable energy insurance in Bulgaria24 The solar industry has experienced rapid expansion in recent years. This has been accompanied by overly optimistic forecasts, however. According to SeeNews, which reports business, economic and financial news from South-Eastern Europe, their recent study found the majority of photovoltaic installations in Bulgaria underperformed their forecast P50 model (a 50 per cent probability that production in a year will be at least a specific amount) by more than 6 per cent, while 25 per cent of the plants underperformed by over 10 per cent. At the same time, many solar developers seek long-term equity to fund projects from a variety of sources, ranging from public markets to private equity. This means the solar industry faces increasing demand to meet investors’ expectations. Against this backdrop, Bulgaria-based Renewable Energy Insurance Broker (REIB) has recently partnered with Colonnade, an ‘A’-rated insurance company, to offer a solution that hedges against reduced yields. The solution takes into account several factors that may lead to underperformance: ●● ●●

less solar radiation than forecast; performance of the facility’s components below the minimum performance forecast by the manufacturer;

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power grid interruptions; and

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above-average or excessive wear.

The insurance premium is based on the forecast energy return. At the end of the insurance term, this projection is compared with the real energy return. In the event where the actual performance was less than 90 per cent of the projected output, the investor is entitled to a payout. The amount is calculated based on the gap between the real and 90 per cent of the forecast yield multiplied by the electricity price according to the relevant power purchase agreement. For example (assuming electricity price is €0.08): 100% forecast 90% forecast (insured level) Actual yield 1,800,000 kWh

1,620,000 kWh

Loss amount

1,500,000 kWh 120,000 x €0.08 = €9,600

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READING Renewable energy insurance: renewed efforts25 Global renewable energy capacity grew at record rates in 2016, with investments in solar greater than investment in any other electricity-producing technology during that year. David Adams looks at how the insurance market is responding. Global renewable energy capacity grew by 161 gigawatts (GW) in 2016, a record annual increase, according to energy policy network REN21. Around half this new capacity came from solar power, which means that investments in this form of renewable energy were greater than investment in any other electricity-producing technology made during 2016. New renewables capacity installed across the globe in 2016 cost $242 billion, 23 per cent less than was invested in new renewable capacity during 2015; the cost of building and operating solar and wind energy installations has fallen significantly. In the UK, in June 2017, the National Grid announced that a new record for renewables generation meant that for the first time, a combination of solar, wind, biomass and hydropower sources had made a greater contribution to electricity generation (50.7 per cent) than fossil fuels. Still, it is important to keep these figures in context. Renewables contributed 10 per cent of global energy generation in 2016, still far behind the 80 per cent generated using fossil fuels. Although they contributed almost a quarter (24 per cent) of global electricity generation in 2016, most of this was produced by hydropower. Wind generated 4 per cent and solar 1.5 per cent. Yet the clear upward trend in the use of renewables and the fall in costs have both been very clear during recent years. So how have insurers responded to the expansion of the renewable energy industry, to cover risks around renewables, from microgeneration to large-scale projects? Murray Haynes is a partner and a renewable energy risk specialist at Alesco, which arranges multi-line insurance and reinsurance for businesses during the construction and operation of renewable energy projects and facilities. He says the core insurance products used to insure renewables are those you would expect to use to insure any construction project or operational facility. For example, during the construction phase there is a need for marine cargo cover, various covers for damage due to natural causes and delay in start-up insurance to cover income loss caused by delayed project completion. During the operational phase, there would then be a requirement for insurance to cover operational risks related to damage to property, in particular, and business interruption insurance to cover fixed costs during a major disruption. Other covers that might be more or less relevant depending on the location of a project could address risks such as terrorism, sabotage and industrial action.

Insurance – impact underwriting

Cover against other political risks may also be necessary, in case such eventualities as changing tariff rates or outbreaks of civil unrest, for example, prevent access to facilities. It is also not unheard of for a government to seize assets, or to stop businesses using foreign exchange to take money out of the country. None of these issues are unique to renewable energy facilities, of course; more specific risks include those related to offshore projects (the vast majority of renewable projects are onshore). Premiums for offshore projects can be up to five times more expensive than equivalent projects or operations on land, in part simply because of practicalities. If an offshore wind turbine becomes badly damaged, for example, it may be necessary to recover hardware from the seabed, which can be a very expensive undertaking. Renewable insurance needs can vary significantly. Consider, for instance, the physical conditions that might affect wind turbines in northern Scandinavia, where a build-up of ice on turbines can disrupt operations and/or create additional risks to people or property nearby; or the risks facing facilities in areas prone to extreme weather or earthquakes. Such natural catastrophe perils ‘weigh quite heavily on underwriters’ minds,’ according to Haynes. However, insurers have also written policies to address more specific requirements around scale or technology. The range of renewables-related products now offered by the broker Lycetts, for example, includes cover for landowners investing in anaerobic digestion technology for waste management and fuel production; insurance for biomass and geothermal generation; and policies tailored for microhydro electricity generation schemes, alongside insurance for solar and wind energy generation projects. Specialist broker Nviro has also developed policies covering the lesser-known forms of renewables for projects of varying sizes. Its hydro power insurance solutions may suit small projects, including community generation initiatives and watermill renovations. The company also offers insurance for newer renewable technologies, including tidal and wave energy; desalination and osmosis energygeneration technologies; kinetic energy generation; fuel cells; and carbon capture and storage. XL Catlin, meanwhile, is leading the insurance programme for the ITER experimental fusion project, a scientific venture seeking to demonstrate the technical feasibility of using nuclear fusion to develop a limitless source of energy. The organization is currently building a magnetic structure to control and confine fusion processes taking place within plasma heated to 150 million degrees centigrade. For most renewables-based projects, however, the reality of insurance is a little more traditional. One final group of risks to highlight is that related to ‘series losses’, where design or manufacturing defects, or a widely used installation method,

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may result in the same claim being made for many multiples of the same piece of equipment. To counter this, underwriters may insert a series losses clause to limit the number of times they will pay out on claims with an identical cause. Haynes does not feel there are any particularly striking trends in claims related to renewables at present – many claims are technology-specific, others relate to more generic risks, such as accidental damage of assets in transit or during construction. He does pick out one trend, however: losses related to cabling used for offshore wind facilities. Cable losses are thought to account for about half of all losses related to offshore wind projects. These problems may include damage to cables that occurs during their manufacture, or in transit – or by the installer, such as over-twisting of cabling. Cables can also easily be damaged during the process of laying them on the sea bed: laying one cable may dislodge and damage another, for example. Sometimes the sea bed erodes under cabling, leaving lengths of cable hanging between rocks, which can also cause damage. Repairing these cables can be very expensive: the cost of chartering a specialist vessel for several weeks can be extremely high. But it may also be unavoidable, particularly if it is the large export cables which carry energy back to the shore that are damaged. Even those businesses that need to sacrifice more of the potential returns on renewables investments on insurance at least have the consolation that now is a good time to be buying these policies. ‘There’s a lot of capacity in the market at the moment,’ Haynes points out. ‘Underwriters have a commercial imperative to be competitive.’

Energy efficiency insurance Driven by the combination of factors outlined previously, including tighter, ‘green’ building codes and standards, the need to reduce energy costs and greater awareness of the social, environmental and financial benefits of improving energy efficiency, many commercial property owners and managers invest in substantial energy efficiency projects. These can include replacing windows and insulation, upgrading heating and cooling systems, installing new lighting and other electrical systems, and installing solar, wind or other sources of renewable energy. The capital costs of such projects can be high, especially when older buildings require significant retrofitting, but the expectation is that these will be recouped over time by substantially lower annual running costs. Energy efficiency insurance can reduce the risk to building owners and managers of not achieving the anticipated savings by (usually) providing cover in three areas: ●●

material damage – the risk of damage or destruction of energy-saving equipment installed, such as solar panels;

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●●

business interruption – the risk of losses in business revenue caused by events associated with the energy-saving equipment installed; if, for example, a power failure causes production stoppages; energy performance – the most important and innovative part of energy efficiency insurance, this covers any shortfalls in actual versus expected energy and cost savings.

Energy efficiency insurance is considered key in promoting the uptake of energy efficiency measures, particularly by SMEs in the developing world. Improving energy efficiency should reduce costs, making businesses more profitable and releasing funds for growth. In many developing countries, however, funding for energy efficiency upgrades tends to be limited; SMEs and local banks often lack the technical capacity to assess the potential of capital-intensive energy efficiency investments, and lack confidence in the data that these will generate positive returns. To address this barrier to investment, the Inter-American Development Bank (IDB), the Danish government and BASE (formerly the Basel Agency for Sustainable Energy) have developed ‘Energy Savings Insurance’ (ESI), introduced in the case study below. In the ESI model, it is providers of energy efficiency technology, rather than building owners, that purchase the insurance to back guarantees to their SME clients on the energy performance of and financial savings from their products and services. The Climate Finance Lab has found this can absorb up to 80 per cent of the underperformance risk and thus incentivize energy efficiency upgrades. A pilot scheme has been implemented in Mexico with a target of stimulating $25 million of investment in 190 energy efficiency projects in the agro-industry sector. Further opportunities are being considered in other developing countries; in the long term, it is estimated that ESI and similar schemes could support up to $100 billion in energy-efficient investments.

CASE STUDY Scaling up energy efficiency with Energy Savings Insurance26 The energy savings insurance model aims to scale up investments in energy efficiency, facilitate the flow of financing for these technology solutions, and address the untapped market potential. The challenge Energy efficiency presents enormous investment opportunities for businesses with significant potential to reduce greenhouse gas emissions, especially in developing countries. However, many development programmes targeting energy efficiency

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have struggled to catalyse the market. One of the main reasons is that energy efficiency is not a priority for many businesses, such as hotels or agribusinesses. The concept of ‘energy efficiency’ can be difficult to sell; it requires providers of technologies like air conditioning or boilers to change the way they approach businesses. Instead of simply selling new technology, a provider needs to sell a promise of future energy savings that should be high enough to justify the investment. Businesses are not used to buying future energy savings, especially in developing countries. Many have a lack of trust in the technologies, and often do not see the need to replace a working piece of equipment that they already have. Many development programmes aim to drive the market for energy efficiency by providing financing, but this alone is not enough to convince businesses to invest in promised energy savings. The solution In order to motivate small and medium-sized enterprises (SMEs) to invest in energy efficiency and generate a continuous pipeline of bankable projects, it is fundamental to build trust and credibility among key actors and reduce the risk-return trade-off perception. With the support of the Inter-American Development Bank and the Danish government, BASE developed an Energy Savings Insurance (ESI) model that comprises financial and non-financial mechanisms designed to work together to overcome barriers, create trust and reduce the perceived risks for stakeholders. The model consists of risk mitigation instruments, including insurance, standardized contracts and a simplified validation process, which together help to mobilize financing. BASE has also developed an ESI Toolkit that offers step-by-step instructions on how national development banks can establish a programme that is able to catalyse the energy efficiency market. The outcome The ESI model is being planned, developed or rolled out with different partners in various countries across Latin America, Africa, Asia and Europe. The ESI model was recognized by the Global Innovation Lab for Climate Finance as one of the most promising instruments to mobilize private sector investments in energy efficiency. The A.M. BEST insurance rating agency featured it as one of the most innovative insurance products of 2015, and the Clean Energy Finance Forum at the University of Yale identified ESI as a winning idea and a successful financial vehicle for climate change mitigation. The ESI model also features in the G20 Energy Efficiency Investment Toolkit, published in 2017.

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QUICK QUESTION Which ‘green’ insurance products and services are available from your personal or corporate insurer, or broker?

Carbon credit/carbon credit delivery insurance One emerging area of commercial and corporate insurance that has the potential to grow rapidly is insuring risks related to carbon credits and greenhouse gas emissions reductions. As discussed in Chapter 5, while carbon pricing and carbon credit markets are growing, especially in Europe, they can be volatile and subject (in many jurisdictions) to changing political and regulatory requirements. It may be difficult or impossible, therefore, for organizations wishing to purchase carbon credits to offset against emissions to be certain of the future value or eligibility of those credits. This increases the risk of purchase. Carbon credit insurance offers certainty in terms of future value, in exchange for insurance premiums. Carbon credit delivery insurance is also related to carbon markets and emissions trading schemes whereby organizations that reduce carbon emissions gain carbon credits (or can obtain these at subsidized prices) that may then be traded. Organizations can insure the risk that their emissions-reduction activities might fail to achieve the anticipated reductions, and therefore will not receive the anticipated carbon credits and future revenue from these.

Climate (climate risk) insurance We saw in the introduction to this chapter how climate change impacts the insurance sector, particularly large insurers mainly based (at least until recently) in developed, Western markets. Climate change disproportionately affects the world’s poorest and most vulnerable communities, however. Moreover, when extreme weather events occur or the impact of other climate-related events (such as rising sea levels) are experienced, those living in or close to poverty are the least able to cope due to their lack of savings, government support and other safety nets. The most vulnerable are the world’s 2+ billion individuals reliant on subsistence or small-scale agriculture and fishing, living in those regions most vulnerable to climate change (in low-lying coastal areas or in parts of the world most affected by drought and water shortage). Few such individuals, smallholders, small businesses and communities have access to private insurance coverage to protect themselves, their families, their homes,

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possessions and livelihoods from climate risks. In many cases, poorer communities are more vulnerable to the impacts of climate change because of where they are located, and less resilient because of the lack of support. As a result, several insurance products have emerged in recent years with the aim of mitigating the impacts of climate change and enhancing the resilience of individuals and communities in the developing world. Although insurance may cover a wide range of climate-related risks to which businesses are exposed, in this context the terms ‘climate insurance’ and ‘climate risk insurance’ are most often used in relation to providing insurance to individuals, communities and countries in the developing world that are most exposed to climate change. In this section, we look at two approaches to climate risk insurance in the developing world: sovereign catastrophe risk pooling and index insurance.

Sovereign catastrophe risk pooling Sovereign catastrophe/disaster risk pooling occurs when governments or other organizations (such as humanitarian agencies acting on behalf of impacted communities) take out insurance against natural catastrophes, including extreme weather and other climate-related events. By pooling the risks, countries and communities can create a more diversified portfolio, and reduce the cost of premiums compared to insuring single, high-impact and high-cost risks. When a catastrophic event occurs, the insurance policy will (usually) provide a rapid pay-out that can be used to fund disaster relief and recovery programmes. The advantage for governments and other agencies is that the pay-out from the insurer enables funds to be released without having to utilize existing budgets. Such funds are more quickly available than those that come through other disaster relief channels, such as appeals and grants.

READING What makes catastrophe risk pools work: lessons for policymakers27 Securing access to financial resources before a disaster strikes by means of sovereign catastrophe risk pools allows countries to respond quickly to disasters and reduce their impact on people and their livelihoods. This is what islands in both the Caribbean and the Pacific have done over the last decade through regional risk pools – the Caribbean Catastrophe Risk Insurance Facility (CCRIF SPC) and the Pacific Catastrophe Risk Assessment and Financing Initiative (PCRAFI) Insurance Program.

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In the aftermath of Hurricanes Irma and Maria, CCRIF SPC provided $29.6 million in payouts in less than 15 days to six Caribbean countries: Antigua & Barbuda, Anguilla, Haiti, Saint Kitts & Nevis, The Bahamas, and Turks & Caicos Islands, while in Dominica, the CCRIF SPC, along with an existing World Bank disaster reduction project, made a $19 million payout. Likewise, in 2015, just seven days after Cyclone Pam devastated Vanuatu – leaving one-third of the island’s population homeless and causing damages equivalent to more than 60 per cent of GDP – the government received a $2 million payout from the insurance policy it had purchased through PCRAFI. While $2 million may not be a large amount of money, it was eight times the government’s emergency provision, and was critical for funding urgent priorities such as flying medical personnel to the worst affected areas. Through sovereign catastrophe risk pools, countries can pool risks in a diversified portfolio, retain some of the risk through joint reserves and capital and transfer excess risk to the reinsurance and capital markets. Since it is highly unlikely that several countries will be hit by a major disaster within the same year, the diversification among participating countries creates a more stable and less capitalintensive portfolio, which is cheaper to reinsure. By putting a price tag on risk, sovereign catastrophe risk pools can also create incentives for countries to invest in risk reduction. This is important because donor assistance is struggling to meet the rising cost of disasters, and insurance coverage remains low in vulnerable countries. At the same time, disaster losses are on the rise, with climate hazards increasing in frequency and intensity, and more people and assets in harm’s way. Already, the impact of natural disasters is equivalent to a $520 billion loss in annual consumption, and forces some 26 million people into poverty each year. In the last 10 years, 26 countries in three regions – Africa, the Pacific, and the Caribbean and Central America – have joined three sovereign catastrophe risk pools, thanks in part to contributions from donors, who provided technical and financial resources to support them. They have purchased parametric catastrophe risk insurance for an aggregate coverage of $870 million and an aggregate premium volume of $56.6 million, backed by more than 30 reinsurance companies. The three pools have made $105 million in payouts to date.

In November 2017, the InsuResilience Global Partnership for Climate and Disaster Risk Finance and Insurance Solutions was launched at COP23 in Bonn.28 It now has more than 100 members from 16 developed and developing countries, plus a wide range of intergovernmental and international financial institutions, with the

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aim of increasing resilience amongst those communities most vulnerable to climate change. In particular, InsuResilience plans to support the creation of effective climate risk insurance solutions for people, infrastructure and assets at risk in developing countries.

Index insurance Index insurance pays out for losses resulting from extreme weather and other catastrophic events on the basis of deviations from a predetermined index of one or more generally weather- or agriculture-related parameters (such as rainfall, water levels, temperature, crop yield, livestock mortality). Advances in satellite, drone, weather station and other monitoring technologies have made it easier and cheaper to track the desired parameters, and pay-outs to small farmers and other insured individuals and small businesses are triggered automatically when data breaches previously agreed thresholds. Combined with the use of smartphones to assist with monitoring and as a mechanism for payment, the settlement and pay-out process is much quicker and cheaper to administer than traditional insurance. Index insurance is available to individuals (the ‘micro’ level) and to collective groups such as farm cooperatives that can pool premiums and risks (the ‘meso’ level). It is also being increasingly used by banks and other lenders in the developing world to insure their microfinance portfolios. According to an overview of climate risk insurance published by Results, index insurance dramatically lowers transaction costs. It has made access to insurance for individuals, families and small farmers in the developing world possible, increasing the resilience of those communities most impacted by climate change. By increasing the certainty and speed of settlements and pay-outs, it also supports small entrepreneurs and farmers, encouraging investment that might otherwise not be possible.29

CASE STUDY Climate insurance for farmers: a shield that boosts innovation30 New insurance products geared towards smallholder farmers can help them recover their losses, and even encourage investment in climate-resilient innovations. What stands between a smallholder farmer and a bag of climate-adapted seeds? In many cases, it’s the hesitation to take a risk. Farmers may want to use improved varieties, invest in new tools or diversify what they grow, but they need reassurance that their investments and hard work will not be squandered. Climate change already threatens crops and livestock; one unfortunately timed dry spell or flash flood can mean losing everything. Today, innovative insurance

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products are tipping the balance in farmers’ favour. That’s why insurance is featured as one of 10 innovations for climate action in agriculture, in a new report released ahead of next week’s UN Climate Talks. These innovations are drawn from decades of agricultural research for development by CGIAR and its partners, and showcase an array of integrated solutions that can transform the food system. Index insurance is making a difference to farmers at the frontlines of climate change. It is an essential building block for adapting our global food system and helping farmers thrive in a changing climate. Taken together with other innovations like stress-tolerant crop varieties, climate-informed advisories for farmers and creative business and financial models, index insurance shows tremendous promise. The concept is simple. To start with, farmers who are covered can recoup their losses if (for example) rainfall or average yield falls above or below a pre-specified threshold or ‘index’. This is a leap forward compared to the costly and slow process of manually verifying the damage and loss in each farmer’s field. In India, scientists from the International Water Management Institute (IWMI) and the Indian Council of Agricultural Research (ICAR) have worked out the water level thresholds that could spell disaster for rice farmers if exceeded. Combining 35 years of observed rainfall and other data with high-resolution satellite images of actual flooding, scientists and insurers can accurately gauge the extent of flooding and crop loss to quickly determine who gets pay-outs. The core feature of index insurance is to offer a lifeline to farmers so they can shield themselves from the very worst effects of climate change. But that’s not all. CIMMYT is investigating how insurance can help farmers adopt new and improved varieties. Scientists are very good at developing technologies but farmers are not always willing to make the leap. This is one of the most important challenges that they grapple with. What they’ve found has amazed them: buying insurance can help farmers overcome uncertainty and give them the confidence to invest in new innovations and approaches. This is critical for climate change adaptation. They’re also finding that creditors are more willing to lend to insured farmers and that insurance can stimulate entrepreneurship and innovation. Ultimately, insurance can help break poverty traps, by encouraging a transformation in farming. Insurers at the cutting edge are making it easy for farmers to get coverage. In Kenya, insurance is being bundled into bags of maize seeds, in a scheme led by ACRE Africa. Farmers pay a small premium when buying the seeds and each bag contains a scratch card with a code, which farmers text to ACRE at the time of planting. This initiates coverage against drought for the next 21 days; participating farms are monitored using satellite imagery. If there are enough days without rain, a farmer gets paid instantly via their mobile phone.

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Farmers everywhere are businesspeople, who seek to increase yields and profits while minimizing risk and losses. As such, insurance has widespread appeal. Successful initiatives have grown rapidly in India, China, Zambia, Kenya and Mexico, which points to significant potential in other countries and contexts. The farmers most likely to benefit from index insurance are emergent and commercial farmers, as they are more likely than subsistence smallholder farmers to purchase insurance on a continual basis. It’s time for more investment in index insurance and other innovations that can help farmers adapt to climate change. Countries have overwhelmingly prioritized climate actions in the agriculture sector, and sustained support is now needed to help them meet the goals set out in the Paris Climate Agreement.

The balance of responsibility While climate risk insurance such as sovereign catastrophe risk pooling and index insurance can improve resilience to the impacts of climate change, critics have expressed concern about measures that make those (in most cases) least responsible for climate change bear responsibility for its risks and costs. Climate risk insurance also does little to deal with the underlying causes of climate change, and concern has been expressed regarding the potential unintended consequences of poorly designed or implemented schemes.

READING Climate insurance: closing the protection gap or the resilience gap?31 Does climate insurance work as a catalyst for climate risk management and sustainable development? Or is insurance deflecting attention from other disaster risk management solutions? Swenja Surminski, Senior Research Fellow at the London School of Economics, argues there is no simple answer. Insurance can help reduce the impacts of natural disasters and build resilience Disaster insurance instruments, such as micro/sovereign insurance mechanisms and risk pools, help to manage the risks of disasters. Immediate insurance pay-outs mean recovery and rebuilding can begin rapidly after a disaster, without waiting for government to reallocate funds. This implies that closing the protection gap could be an important element in a climate risk management strategy. Experience from developed countries shows that insurance can play a costeffective role in a country’s efforts to increase its disaster resilience. This has

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spurred efforts to test insurance across developing countries, with a range of new schemes being piloted, and international support money being pledged to increase the use of insurance, such as the G7 InsuResilience initiative. But does insurance really increase the climate resilience of the most vulnerable people? While disaster insurance offers many opportunities, it is far from clear how insurance schemes improve climate risk management and support climate-resilient development. There is uncertainty about how to monitor and evaluate resiliencebuilding, and there are few rigorously designed studies to examine the impact that these insurance schemes have. A recent study for the Climate Investment Fund warned that climate insurance could also have unwanted consequences and may not benefit the poor or foster climate resilience. Poorly designed or implemented climate insurance may reduce incentives for risk reduction. This would increase moral hazard and potentially lower resilience through a false sense of security. This is a key area of concern. Several of the development aid-funded schemes such as sovereign risk pools have to conduct evaluations, but results will take time and are in some cases not publicly available, creating a lack of trust. The protection gap should not distract from the resilience gap Insurance is an important tool in managing the impact of disasters. However, prevention and preparedness measures are the most effective ways to reduce fatalities and limit damage from disasters. To create longer-term solutions, we need to focus on closing the ‘resilience gap’ between developed and developing countries, while addressing the underlying causes of loss and damage. Insurance as a risk transfer instrument can play a role. However, there is far bigger potential for bringing in the industry’s risk knowledge and expertise. Donors, insurers and NGOs have an opportunity to shape this by embedding climate resilience within their sustainable development agendas. To create longer-term solutions, we need to focus on closing the ‘resilience gap’. What about fairness? Finally, there are equity and fairness dimensions to all of this. Is it fair that those least responsible and least able to pay the premiums should take responsibility for the risk? Subsidies can help to avoid shifting the burden to those most vulnerable, but this also means that insurance may not offer value for money due to high transaction and capital costs. This suggests that international funds might be better spent on other types of safety nets, rather than buying insurance cover from international insurance markets. It is also important to consider how any insurance mechanism will cope with changing risk levels. The intensity and frequency of climate extremes is increasing

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and the cost of insurance is rising, which will put pressure on subsidies and other support measures. Above all, it is important to recognize that there is a moral case beyond the economic considerations. For many parts of the world, loss and damage is not a distant threat but a current reality. The political complexities and technical challenges of climate attribution should not distract from this.

QUICK QUESTION What do you think? Is it more important to address the climate risk protection gap or the resilience gap? Why?

Key concepts In this chapter, we considered: ●●

●●

●●

●●

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the role of insurance within the wider financial system, and how climate-related financial risks are impacting the insurance sector; how different insurance activities can affect the quality and functioning of the natural environment and natural systems; how different types of insurance products and services can improve the quality and functioning of the natural environment and natural systems; how impact underwriting can promote more environmentally and socially sustainable consumer behaviour; and examples and case studies of green and sustainable insurance products and services.

Now go back through this chapter and make sure you fully understand each point.

Review The insurance sector’s core business is to understand, manage and carry risk. By pricing risk and creating a market, insurance enables risk to be pooled, diversified, managed and reduced, thereby protecting society and supporting economic development. With these core competencies, the insurance sector is well positioned to embed

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climate, environmental and broader sustainability risks into its strategies and decision making in terms of both its investing and underwriting activities. Global warming will increase both the severity and frequency of weather-related natural disasters, increasing the physical risks for insurers and both economic and insured losses. The difference between total economic losses from a climate-related event, or a series of such events, and insured losses is known as the climate risk protection gap. While some insurers focus mainly on climate and environmental risk management in response to climate change, others take a more proactive approach to sustainability by offering new, ‘green’ products and services. Insurance that seeks to encourage and support sustainable activities and behaviour by policyholders is often referred to as ‘impact underwriting’. The UN Principles for Sustainable Insurance provide a global framework for the insurance sector to address these and related issues. Life insurers tend to be more affected by risks from their investments on the asset side of their balance sheets. The main way in which life insurers can promote sustainability is through their activities as major institutional investors. Changes to insurers’ regulatory capital requirements can incentivize and support increased investment in climate change mitigation and adaptation. General insurers face more risks from their liabilities than their assets, and they can promote sustainability through impact underwriting – by offering ‘green’ products and services that incentivize more sustainable behaviour by policyholders. Policyholders include individuals (‘personal insurance’) and organizations of all sizes (‘commercial insurance’). Green insurance includes products and services that allow an insurance premium differentiation based on environmentally relevant characteristics or behaviour, and products and services that are tailored to promoting sustainable activities such as the use of renewable energy or other means of reducing greenhouse gas emissions. Green personal insurance products include different types of motor insurance and home insurance. Green commercial insurance products include different types of commercial property insurance, renewable energy insurance, energy efficiency insurance and carbon credit insurance. Environmental insurance provides protection from actual/potential liabilities arising from environmental damage. Climate insurance provides protection against (usually) extreme weather events such as drought, floods and storms. A number of insurance products, usually termed ‘climate risk insurance’, have emerged in recent years to mitigate the impacts of climate change, particularly in the developing world. These include sovereign catastrophe risk pooling and index insurance. Combining remote monitoring, smartphones and other technologies, index insurance reduces the cost and increases coverage, supporting farmers and small

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businesses, and increases the resilience of those communities often most impacted by climate change. Some critics raise concerns that, despite the benefits of such products, they make those least responsible for climate change bear responsibility for its risks and costs. Table 10.1  Key terms Term

Definition

Climate/climate risk insurance

Insurance to individuals, communities and countries in the developing world most exposed to climate change.

Climate risk protection gap

The difference between total economic losses from a climaterelated event (for example, a tropical storm), or a series of such events, and the insured losses.

Energy efficiency insurance

Reduces the risk to building owners and managers of not achieving the anticipated energy and financial savings of capital investment in energy efficiency measures.

Environmental insurance

Insurance that provides protection from actual/potential liabilities arising from environmental damage; for example, coverage to protect against pollution, oil spills or other forms of environmental damage.

General insurers

Insurance companies that provide non-life insurance, which includes property cover, health insurance, liability policies and miscellaneous financial loss cover for individuals, companies and others.

Green insurance

Insurance products and services that either allow an insurance premium differentiation on the basis of environmentally relevant characteristics/behaviour, or are designed to promote ‘green’ activities.

Impact underwriting

Insurance products and services that incentivize policyholders to adopt more sustainable behaviour, contributing to climate mitigation and/or adaptation efforts.

Index insurance

Insurance products that link pay-outs to changes in a predetermined index or set of parameters.

International Green A voluntary code, increasingly widely adopted in national and local Construction Code building codes and standards, promoting a whole-system approach (IgCC) to the design, construction and operation of buildings. The Code sets out criteria in areas including energy efficiency, resource conservation, indoor environmental quality and building performance designed to improve sustainability. Life insurers

Insurance companies that provide benefits in the event of death, retirement or changes in health. (continued )

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Table 10.1  (Continued) Term

Definition

Reinsurers

Insurance companies that provide insurance to other insurance companies, enabling the further diversification of risk.

Sovereign catastrophe risk pooling

When governments or other organizations such as humanitarian agencies take out insurance policies that will provide a pay-out in the event of a defined extreme weather event such as a major drought or hurricane occurring in a country.

UN Principles for Sustainable Insurance (UN PSI)

A global framework for the insurance industry to address environmental, social and governance risks and opportunities.

Usage-based insurance

Vehicle insurance based on how a vehicle is driven (Pay How You Drive – PHYD) and/or the distance driven and type of journey undertaken (Pay As You Drive – PAYD).

Notes 1 UNEP FI (2016) The global insurance industry, Three key roles to play in climate risk management, https://unfccc.int/files/adaptation/workstreams/loss_and_damage/ application/pdf/unep.pdf (archived at https://perma.cc/XE4T-VQKE) 2 UNEP (2017) Sustainable insurance: The emerging agenda for supervisors and regulators, https://www.greenfinanceplatform.org/sites/default/files/downloads/resource/sustain​able%20 insurance.pdf (archived at https://perma.cc/KL7J-QT4P) 3 International Association of Insurance Supervisors (2018) Issues Paper on Climate Change Risks to the Insurance Sector, https://docs.wixstatic.com/ugd/eb1f0b_0e5afc146e44459b9 07f0431b9e3bf21.pdf (archived at https://perma.cc/GV6X-KBHE) 4 EIOPA (2021) Financial Stability Report December 2021, Frankfurt, https://www.eiopa. europa.eu/sites/default/files/financial_stability/financial-stability-report-december-2021_1. pdf (archived at https://perma.cc/TW5S-WLPK) 5 MunichRE (2022) Hurricanes, cold waves, tornadoes: Weather disasters in USA dominate natural disaster losses in 2021, https://www.munichre.com/en/company/media-relations/ media-information-and-corporate-news/media-information/2022/natural-disasterlosses-2021.html (archived at https://perma.cc/98UU-RVT7) 6 Jergler, D (2017) Report highlights climate change risks faced by insurance sector, Insurance Journal, https://www.insurancejournal.com/magazines/mag-features/2018/09/17/500936. htm (archived at https://perma.cc/FS88-Z889) 7 SwissRE (2019) Global catastrophes caused USD 56 billion insured losses in 2019, https:// www.swissre.com/media/news-releases/nr-20191219-global-catastrophes-estimate.html (archived at https://perma.cc/A3UX-8S47)

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Green and Sustainable Finance 8 Cambridge Institute for Sustainability Leadership (2017) 2017 set to be among the most expensive on record after year of climate disasters, insurance leaders warn, https://www. cisl.cam.ac.uk/business-action/sustainable-finance/climatewise/news/2017-set-to-beamong-the-most-expensive-on-record (archived at https://perma.cc/C3AA-9WWN) 9 Casanova Aizpun, F et al (2020) sigma 3/2020: Power up: Investing in infrastructure to drive sustainable growth in emerging markets, Swiss Re, https://www.swissre.com/ institute/research/sigma-research/sigma-2020-03.html (archived at https://perma.cc/​ 5WNS-5FRR) 10 BlackRock (2021) Ninety-five percent of global insurers believe climate risk is investment risk, https://www.blackrock.com/corporate/newsroom/press-releases/article/corporateone/press-releases/ninety-five-percent-of-global-insurers (archived at https://perma.cc/ EQV9-CU8J) 11 European Commission (2021) Reviewing EU insurance rules: encouraging insurers to invest in Europe’s future, https://ec.europa.eu/commission/presscorner/detail/en/ ip_21_4783 (archived at https://perma.cc/8EL9-7LD6) 12 New York Department of Financial Services (2021) Guidance for New York domestic insurers on managing the financial risks from climate change, https://www.dfs.ny.gov/ system/files/documents/2021/11/dfs-insurance-climate-guidance-2021_1.pdf (archived at https://perma.cc/TK77-HQFJ) 13 UNEF PI (nd) Principles for Sustainable Insurance, https://www.unepfi.org/psi/ the-principles/ (archived at https://perma.cc/9ZTZ-LCQB) 14 UNEP FI (2021) Insuring the Climate Transition: Enhancing the insurance industry’s assessment of Climate change futures, https://www.unepfi.org/psi/wp-content/ uploads/2021/01/PSI-TCFD-final-report.pdf (archived at https://perma.cc/R78S-YWKA) 15 Sustainable Insurance Forum (2021) Application Paper on the Supervision of Climaterelated Risks in the Insurance Sector, https://www.sustainableinsuranceforum.org/ view_pdf.php?pdf_file=wp-content/uploads/2021/05/210525-Application-Paper-on-theSupervision-of-Climate-related-Risks-in-the-Insurance-Sector.pdf (archived at https:// perma.cc/6H6R-W8LN) 16 Liverpool Victoria (2022) Electric car insurance, www.lv.com/car-insurance/electric-carinsurance (archived at https://perma.cc/6NC2-J2S3) 17 Ruel, C (2020) Usage-based insurance attracts funding despite drop in insurtech investment, https://www.insurancetimes.co.uk/news/usage-based-insurance-attractsfunding-despite-drop-in-insurtech-investment/1433744.article (archived at https://perma. cc/N8U8-GJJ7) 18 Ptolemus Consulting Group (2018) UBI Infographic 2018: The yearly visual catch-up on the UBI industry, https://www.ptolemus.com/ubi-infographic-2018/ (archived at https:// perma.cc/A5JU-LR57) 19 Frost & Sullivan (2018) Global strategic analysis of usage-based insurance market for passenger vehicles, forecast to 2025, https://store.frost.com/global-strategic-analysis-ofusage-based-insurance-market-for-passenger-vehicles-forecast-to-2025.html (archived at https://perma.cc/9U65-8NFM)

Insurance – impact underwriting 20 International Code Council (2018) Overview of the International Green Construction Code, https://www.iccsafe.org/products-and-services/i-codes/2018-i-codes/igcc/ (archived at https://perma.cc/JG7H-HZJ6) 21 Naturesave (2022) Home, https://www.naturesave.co.uk (archived at https://perma.cc/ PAP2-R769) 22 Scotti, V (2021) How insurance is protecting the world’s second biggest coral reef, Swiss Re, https://www.swissre.com/risk-knowledge/mitigating-climate-risk/insuranceprotecting-coral-reef.html (archived at https://perma.cc/PJQ3-DZFL) 23 Allianz SE (2016) Allianz offers customers an increasing number of Green Solutions, https://www.allianz.com/content/dam/onemarketing/azcom/Allianz_com/migration/ media/press/document/Green-Solutions.pdf (archived at https://perma.cc/9D8R-SF9S) 24 Adapted from Renewable Energy Insurance Broker (2021) Case Study: Renewable Energy Insurance Broker (REIB), https://seenews.com/press_release/view/case-studyrenewable-energy-insurance-broker-reib-764793 (archived at https://perma.cc/ AFE7-VMP6) 25 Continuity Insurance and Risk (2017) Renewable energy insurance: renewed efforts, https://www.cirmagazine.com/cir/renewed-efforts.php (archived at https://perma. cc/9SRK-NRFF) 26 BASE (2020) Energy savings insurance Europe: Unlocking investments in energy efficiency in Europe, https://energy-base.org/projects/energy-savings-insurance-europe/ (archived at https://perma.cc/QG67-5H9E) 27 The World Bank (2017) What makes catastrophe risk pools work: Lessons for policymakers https://www.worldbank.org/en/news/feature/2017/11/14/what-makescatastrophe-risk-pools-work (archived at https://perma.cc/WC5H-B9PT) 28 InsuResilience Global Partnership (2022) Home, https://www.insuresilience.org (archived at https://perma.cc/HF73-BKSR) 29 Results (2016) An introduction to climate risk insurance, https://www.results.org.uk/ guides/introduction-climate-risk-insurance (archived at https://perma.cc/83AX-HZG6) 30 CIMMYT (2017) Climate insurance for farmers: a shield that boosts innovation, https:// www.cimmyt.org/news/climate-insurance-for-farmers-a-shield-that-boosts-innovation/ (archived at https://perma.cc/LZA3-8QRU) 31 Surminski, S (2017) Climate insurance: closing the protection or the resilience gap, Oxfam, https://views-voices.oxfam.org.uk/2017/07/climate-insurance-closing-the-protec​ tion-or-the-resilience-gap/ (archived at https://perma.cc/P6FJ-KTVY)

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­ reen and sustainable G FinTech Introduction In this chapter, we explore how financial technology (FinTech) is transforming many aspects of banking, insurance and investment, and supporting the growth of green and sustainable finance. The combination of FinTech tools and techniques, including smartphone apps, distributed ledgers (blockchain), the Internet of Things (IoT) and ‘big data’ analysis, can improve climate risk management, enhance verification, reporting and regulation, support financial inclusion and resilience, and facilitate access to capital markets. As well as supporting the growth of the sustainable finance sector itself, FinTech can also help align finance more generally with sustainable goals and objectives. Although FinTech represents a generally positive development for green and sustainable finance, potential negative aspects and consequences of the use of FinTech tools and techniques also need to be considered and addressed.

Introduction to FinTech Throughout its history, the financial sector has been one of the earliest adopters and most extensive users of technology. Over the past 20 years, and especially in the last decade, the adoption of digital, data and internet-enabled technologies has transformed – and continues to transform – the financial services sector. Such technologies are often referred to as ‘FinTech’ (combining the words ‘finance’ and ‘technology’) or ‘digital finance’, and are major enablers and disruptors of financial services, reshaping the way finance functions and relates to the economy, environment and society. According to the United Nations Development Programme (UNDP) Task Force on Digital Financing of the Sustainable Development Goals, banks have invested

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L E A R N I N G OB J ECTI VES On completion of this chapter, you will be able to: ●● ●●

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Explain what is meant by FinTech and associated terms. Describe FinTech tools and techniques and how they can support the growth of green and sustainable finance and help align finance overall with the aims of the Paris Agreement, the UN Sustainable Development Goals, and other sustainability objectives. Explain the benefits of applying FinTech tools and techniques to support green and sustainable finance. ­ xplain challenges that may arise from using FinTech tools and techniques E to support green and sustainable finance.

over $1  trillion in developing, integrating and acquiring emerging technologies.1 KPMG estimates that – despite the impact of Covid-19 – venture capital investment in FinTech globally in 2020 totalled $105 billion, following a record $165 billion in 2019.2 ‘Big Tech’ firms such as Apple, Amazon and AliPay, and mobile telecoms operators, are also major FinTech adopters and investors. The Covid-19 pandemic further accelerated the uptake of digital finance, with the use of mobile banking and FinTech apps increasing as individuals and firms found themselves having to work (and bank) from home. FinTech and digital finance are terms used to refer to a wide collection of technologies, including, but not limited to, smartphones and banking apps, the Internet of Things (IoT), Application Programme Interfaces (APIs), distributed ledgers (blockchain), artificial intelligence (AI) and machine learning, and big data and data analytics. Advances in digital technology and data science, new policies and regulations (particularly those aimed at increasing competition in the sector, such as Open Banking in the UK and PSD2 in Europe), wider economic and technological trends (such as a more flexible labour market and the ‘digitization’ of the economy), as well as evolving customer expectations and behaviours (such as rises in the use of digital payments and falling branch footfall), have all accelerated the pace of change in how the finance sector operates. In the early stages of development, FinTech was associated with new start-up firms aiming to challenge the position of large, incumbent financial services organizations in the market. Large financial institutions (including central banks and regulators) and other organizations have since adopted many of the tools and techniques of FinTech and digital finance, in some cases acquiring or partnering with FinTech start-ups.

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QUICK QUESTION Which FinTech products, services and tools do you use at present? Which, if any, contain features that promote environmental or other sustainability factors?

One way to try to capture the breadth of the opportunity for the use of FinTech tools and techniques in sustainable finance is by using the taxonomy developed by the Green Digital Finance Alliance (GDFA) and the Swiss Green Fintech Network (2021). They identify and give examples of FinTech firms working in seven areas in their Green FinTech Taxonomy: ●●

Green digital payments and accounts

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Green digital investment

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Digital ESG data and analytics

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Green digital crowdfunding and syndication platforms

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Green digital risk analysis and insure-tech

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Green digital asset solutions3

Whilst such a classification is useful, the reality is that FinTech tools, techniques and firms are already well embedded right across finance as a whole, as well as in the green and sustainable finance sub-sector. We have already seen many examples of the use of FinTech tools and techniques to support green and sustainable development in earlier chapters, such as Ant Forest in Chapter 6, Climetrics in Chapter 9 and ‘Pay as you Drive’ insurance in Chapter 10. More generally, well-known FinTech products and services include mobile payment platforms (such as AliPay, ApplePay, Square and banking apps provided by new digital ‘challenger’ banks as well as incumbents); retail investment platforms (Nutmeg and Robinhood); price comparison sites (MoneySuperMarket and GoCompare); peer-to-peer (P2P) lending for individuals and businesses (Zopa, Funding Circle); cryptocurrencies (such as Bitcoin and Ethereum); and crowdfunding sites (such as Crowdcube and Kickstarter). There are also a wide range of FinTech applications that support the more efficient and effective delivery of financial services, including ‘RegTech’ (which uses some or all of the technologies outlined previously to better manage regulatory compliance, for example, customer identification and onboarding), ‘PayTech’ (facilitating cheaper and faster interbank payments, often utilizing blockchain), improvements in risk identification, analysis and management, and high-frequency and other types

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of automated, algorithmic analysis and trading. Other examples include InsurTech, a blend of insurance and technology, and LendTech, financial technology to support lending by financial institutions and others. The use of satellite and other remote monitoring techniques (using advanced data analytics) for verifying the environmental and, potentially, social sustainability impacts of projects and investments, discussed in Chapter 4, is another example of the application of the digital and data-driven technologies that are increasingly underpinning finance. And FinTech tools and techniques can be used in retail financial services to help individuals make more sustainable consumption choices. White label FinTech provider Vacuumlabs, for example, worked with Swedish FinTech Doconomy to develop technology that combines data on credit card purchases with carbontracking data to help customers make more sustainable consumption choices.4 UK carbon-tracking FinTech Cogo uses the UK’s Open Banking infrastructure to make APIs and other solutions available to banks wishing to integrate carbon tracking into their banking apps, including one of the UK’s ‘Big 4’ banks, NatWest.5 FinTech tools and techniques, therefore, are relevant and applied throughout much if not all of the financial services value chain. In many countries, payments are increasingly made digitally. This generates a wealth of transaction data; customers can download apps that offer price comparisons and switching services, and can navigate complex financial markets with the support of robo-advisors. Big data and advanced data analytics are used to tailor products and services to customers and better assess credit and insurance risks, enabling new types of loans to be made and more accurate pricing of insurance premiums. Trading is becoming ever more automated and algorithm-led. Central banks are developing digital currencies (sometimes referred to as ‘GovCoins’) and using blockchain-based systems to improve the accuracy, efficiency and security of their wholesale payments, clearing and settlement infrastructure. As we will explore in this chapter, the application of FinTech tools and techniques has the potential to support the continued development of green and sustainable finance and help align finance overall with the aims of the Paris Agreement, the UN Sustainable Development Goals and other sustainability objectives, by: ●●

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increasing the availability, quality and disclosure of sustainability-related data, which can be used to make improved assessments of climate and wider sustainability risks and opportunities; decentralizing and increasing access to services and markets, helping more customers, communities and institutions participate in and engage with green and sustainable finance and finance overall; and lowering the costs and increasing the speed and efficiency of the provision of financial services, providing general social benefit.

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FinTech tools and techniques, especially blockchain, can also be used to support humanitarian projects and objectives. The UN is one of many organizations leveraging blockchain in this way; it did so, for example, as a way of disbursing funds to Syrian refugees in 2020.6 NGOs and companies also use ‘humanitarian blockchain’. hiveonline, for example, uses blockchain to help microeconomies in rural Africa access online payment and banking linked with other data-driven services. One product developed by hiveonline (myCoop.online) offers crop forecasting, voucher distribution and business management services for small farmers, and even works in environments where internet connections and smartphone coverage are poor.7 A related term in common use in green and sustainable finance is ‘CleanTech’ (sometimes also known as ‘GreenTech’), which covers a wide range of technologies linked to environmental management, climate change mitigation and adaptation and other related areas, including, but not limited, to: ●● ●●

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renewable energy (solar, wind and marine, smartgrids, energy storage); energy efficiency (passive buildings, improving power transmission, improving energy usage); resources (recycling, reducing/utilizing waste products and packaging, developing substitutes for high-carbon plastics); transportation and urban infrastructure (public transport, electric and hydrogenpowered vehicles); and sustainable food production and land use (agriculture, aquaculture and forestry).

Developments in the CleanTech sector are beyond the scope of this chapter and book, but are clearly an area of great interest to Green and Sustainable Finance Professionals seeking to support the transition to a more sustainable, low-carbon world, as they encompass many of the infrastructure and technology investments needed for successful climate change mitigation and adaptation. Industry events such as the GreenTech Festival8 may also be of interest to Green and Sustainable Finance Professionals who wish to find out more about technological developments in this area.

Applying FinTech tools and techniques in green and sustainable finance In recent years, there has been significant global interest in applying FinTech tools and techniques to support the growth of green and sustainable finance. This has included a range of policy initiatives led by bodies including the UNDP and UNEP, which we introduce below, and the development and deployment of innovative digital finance and technology-led solutions by new start-ups and incumbents alike, some of which

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are presented later in this chapter. Some of the key features and benefits of FinTech for the green and sustainable finance sector include: 1 Improving access to financial services: The availability of banking, insurance and other financial products and services via smartphones and other devices means greater numbers of individuals and small businesses – especially in the developing world – can access services such as microfinance and insurance to finance mitigation/adaptation activities and enhance climate resilience. 2 Lowering the costs of delivering financial services: Process automation, the delivery of financial services via digital channels and the use of advanced data analytics to better understand and price risk, can lower the costs of providing financial services, making previously unbanked/uninsured individuals and small businesses more attractive to providers. 3 Improving access to capital markets: The combination of FinTech tools and techniques, including digital platforms and distributed ledgers, can reduce the cost of issuing bonds and other securities, making it easier for smaller businesses and projects to receive funding that is currently only accessible by larger issuers (as we will see below, this is particularly important in the context of green and sustainable finance). 4 Increasing efficiency: As well as providing cost efficiencies, the use of FinTech tools, such as smart contracts, can automate services (for example, approving and paying out climate insurance claims) without the need for human intervention. 5 Decentralization: Distributed ledger (blockchain) and smart contract technology enable the tracking and direct transfer of digital assets without the need for trusted intermediaries, further reducing costs. 6 Improving risk management: Access to and analysis of data over a wide range of green and sustainable finance-related areas (for example, climate data, emissions tracking) make it easier for financial institutions and others to identify, assess, manage and disclose climate and other environmental risks. 7 Enhancing transparency and market integrity: The availability of monitoring and verification data from satellites, drones, smartphones and other sources makes the verification and publication of impact data (such as factory emissions, de- or re-forestation) more robust, cheaper and more accessible. 8 Promoting competition: FinTech start-ups can experiment with innovative approaches to providing financial services that might be difficult or impossible for large incumbents, which may lead to new services promoting sustainability and/or serving previously under-served or marginalized groups. 9 Targeting investors: Digital platforms and data analytics enable issuers, fund managers and others to target retail or institutional investors with an appetite for green and sustainable finance investment.

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10 Changing consumer behaviour: Apps that can track customer spending behaviour and link this with emissions data can estimate carbon footprints and ‘nudge’ consumers towards more climate-positive or other socially desirable spending and behaviours. 11 I­ mproving financial literacy: Many banking apps and the like offer budgeting tools and other financial education resources to support financial inclusion and reduce indebtedness.

QUICK QUESTION Which of the features and benefits of FinTech tools and techniques listed above are, in your view, most relevant to green and sustainable finance?

According to the UNDP Task Force on Digital Financing of the Sustainable Development Goals,9 FinTech tools and techniques (referred to as ‘digitalization’) are already helping many individuals and small businesses gain access to financial services and align finance with sustainability goals (see the reading on p 558). The Task Force identified five areas where this is the case: ●●

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Digitalization has increased financial inclusion by helping hundreds of millions of women, rural residents, people on low incomes, young people and small business owners seamlessly transact, safely save, cheaply borrow, securely invest and more easily become insured. Digitalization has helped incorporate SDG-related risks (sometimes termed ‘environment, social and governance’ factors, or ‘ESG’) into growing volumes of lending and investment; in recent times this has most visibly included climate-related risks, but also includes other environmental and social factors that present a material risk to financial returns. Digitalization helps people align the use of their money with their own interests and goals, as witnessed by the rapid growth in impact and automated ‘robo-investing’, and the growth of SDG-aligned lending and investing opportunities. Digitalization can empower citizens as taxpayers and users of public services by increasing the ease and accessibility of tax and payment systems for public services and providing greater transparency in the public allocation and use of funds. Digitalization has enabled people to access capital-intensive services and optimize the use of their own assets through shared economy approaches such as productas-a-service, smart metering, pay-as-you-go and rent-to-own.

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READING Greening digital finance10 Digital finance has the potential to overcome some of the pervasive barriers to deploying private finance for the greater good, and so to improve environmental outcomes. On the supply side, digital finance reduces costs and increases speed, providing a foundation for identifying and creating profitable green savings and investment opportunities. Trine, a Swedish tech start-up, enables savers in downtown Stockholm to profitably fund distributed solar energy systems in rural sub-Saharan Africa. On the demand side, similarly, reduced financing costs and pay-as-you-go access to clean energy open up new markets, particularly for poorer consumers. Kenya’s M-KOPA is leveraging the hugely successful domestic mobile payments platform, M-PESA, to open up clean energy to poorer communities. The prize could be very large. ANT Financial Services, with 450 million users of its mobile payments platform in China alone, has launched a ‘green energy’ app that rewards users for reduced carbon use, revealed through a set of algorithms that translate individuals’ financial transaction data into an estimate of their carbon footprint. Extending just this single carbon-saving rewards initiative across a number of payments platforms could engage hundreds of millions of individuals in making carbon-saving lifestyle decisions on a daily basis. FinTech is not a solitary technological disruptor. It is part of a broader technological ecology that centrally includes the IoT and AI. As such, it will increasingly ‘animate the physical world’, integrating physical and natural assets by enabling interactions that in turn drive them to sense and respond to each other in real time. Just as blockchain technology will create a ‘history’ to money, revealing where it has been and what it has done, so will the lifecycle of a product, its interaction with the environment and its financing also become easily traceable. The impact of this technological surge goes beyond enabling new decision-making opportunities based on objective data and new business models. Behavioural norms will also be reshaped as personal and group identities are increasingly shaped through virtual experience. ANT’s carbon-saving initiative is closely tied not only to its financial services proposition, but also to its social media strategy, in recognition of its potential for eliciting even greater behavioural change. All revolutions come at a price. Incumbent financial institutions that cannot evolve rapidly, and the people dependent on them for their livelihoods, will be the first to pay as they are cut out of profitable parts of the financial value chain. The eradication of Kodak and Nokia in the face of early-stage digital upheaval comes to mind as minor rehearsals of what is to come. The misuse of new financial technologies is inevitable, although every effort must be made to prevent it. Loss of privacy is the most visible penalty, and is likely, despite noble efforts at creating safeguards. Less visible are the negative effects of the disruption of existing markets. In his

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best-selling book Flash Boys, Michael Lewis revealed the negative impacts of high-frequency trading on the financial returns from our lumbering, 20th-century pension funds.11 Regulation itself will be a casualty, at least for a while, as financial regulators struggle to oversee and guide an ever-more complex, dynamic and virtual financial system. Some commentators, such as the FT’s Izabella Kaminska, have argued that the commoditization effects of speed and big data itself undermine the conditions for sustainable development. It is certain that FinTech will reshape the global financial system and its relationship with both the societies in which we live and the ecosystems on which we depend. Harnessing technology for the greater good has been a challenge throughout history. In that sense, aligning digital finance and its close cousins with the imperatives laid out in the Sustainable Development Goals (SDGs) is just another iteration of such efforts. Some solutions will be framed by compliance, some by standards and the rule of law, and others by riding the technological wave through innovation. Here, we would emphasize three, related solution arenas: 1 The digital finance community needs to be rapidly aligned with sustainable development imperatives to prevent the emergence of a new generation of incumbent, problematic financial institutions. 2 Financial policymakers and regulators need to embrace sustainable development as core to their engagement with the FinTech community, most immediately in their ongoing ‘regulatory sandbox’ experiments. 3 The sustainable development finance community is woefully ignorant of the significance of these developments, and needs to wake up and engage now, or it risks becoming irrelevant, or worse.

As we have explored in earlier chapters, the green and sustainable finance sector is growing rapidly, driven by changing consumer preferences and values, evolving policy and regulatory interventions, and an increasing understanding of climate and broader sustainability risks and opportunities. This increases the demand for innovative solutions, products and services supported by a range of FinTech tools and techniques across the financial services landscape – retail and corporate banking, investment and insurance. We will now explore each of these in turn.

Retail financial services Some of the most obvious applications of FinTech tools and techniques, at least to the general public, may be found in retail financial services, including services for micro and small businesses such as:

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promoting green and sustainable finance to retail customers, and encouraging and supporting behavioural change by providing products and services, such as current accounts and payments, that ‘nudge’ and/or reinforce green and sustainable financial and purchasing decisions (for example, the Nordea Carbon Footprint Tracker described below, and Ant Forest, referred to above and described in Chapter 6); providing access to banking, insurance and other financial services, particularly in developing markets, where smartphones with cameras and fingerprint readers can be used to prove identity, onboard customers and deliver financial services, including payments, credit and insurance that support financial inclusion and/or climate mitigation and resilience; s­ upporting lending via microfinance and other institutions to climate-smart agriculture, forestry, fisheries and other sectors, where traditional approaches to credit scoring, loan disbursement and repayment, and monitoring environmental outcomes would require expensive branch networks but can be delivered much more cost-effectively with technology; utilizing the increasing availability and granularity of data relating to climate risks and opportunities, and advances in data analysis techniques, to better price risk and return for individuals, businesses and communities, enabling financial services firms to offer a wider range of green and sustainable products and services (for example, green mortgages and loans, climate insurance) – although data availability and quality is still skewed towards the developed world; and channelling retail investors’ savings to support loans or small investments in environmentally sustainable companies and organizations through aggregator and marketplace apps, peer-to-peer (P2P) lending or crowdfunding platforms (such as Bettervest, as described in the case study below, and Inyova).

CASE STUDY Individual carbon footprints for Nordea’s digital banking customers12 Three million digital banking customers at Nordea Bank in Sweden can track their individual carbon footprint using a CO2 tracker built into their mobile and digital wallets. The system works by tracking customer spending on debit and credit cards across merchant categories such as transport, groceries, clothing and entertainment. Estimated CO2 emissions are then calculated using the Åland Index, originally developed by the Bank of Åland in Finland. The resulting carbon footprint is an estimate only, as individual product-level data is not available. Nordea Bank customers can track their estimated CO2 impact on a monthly basis, via their Nordea Mobile App and Nordea Wallet, and hopefully adjust their consumption and spending decisions accordingly.

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Launching the new service in late 2019, Sara Mella, Acting Head of Personal Banking at Nordea, said: ‘The tracker is a good place to start for those of our customers who want to make a positive impact on the climate as they can use the insight they get about their daily spend to actively reduce their CO2 impact or compensate for it.’

QUICK QUESTION Have you measured your own carbon footprint? Are there tools available where you live and work to help you do this?

CASE STUDY Bettervest13 Bettervest describes itself as an online platform for impact investments. Trend researcher and futurist Patrick Mijnals came up with the idea in 2006, focusing initially on energy efficiency projects in Germany. His vision was to use energy efficiency to provide impetus for a climate-friendly economy and society, and that ordinary people should be able to invest in it via the use of a crowdfunding approach. This has now expanded to encompass a wide range of environmental and social impact investment opportunities in Germany and around the world. The Bettervest platform enables individuals to jointly invest – via subordinate loans and bonds – in renewable energy, resource efficiency and other projects initiated by companies, NGOs and local municipalities. Using the funds raised, projects can develop and deploy technologies leading to cost, energy and CO2 reductions, and/or take advantage of opportunities for environmentally positive products and services. The platform thus opens up sustainable investment opportunities to small private investors who want to combine financial returns with impact returns. Eligible projects are assessed by certified consultants, and are regularly monitored throughout the investment term. Project owners commit to using revenues generated and/or annual cost savings to pay back investors over a fixed contract period until the initial investment sum plus interest has been paid off. Once the contract period has ended, the savings remain in the project owner’s company. The Bettervest platform itself is financed by a percentage commission (based on the investment sum) and an annual handling fee during the contract period.

Green and sustainable FinTech

P2P lending and crowdfunding platforms grew significantly in number and in scale following the Global Financial Crisis, although more recently some of the largest P2P lenders have scaled down or exited the market, because the model of disintermediating established lenders has not been universally successful. Specialist ‘green’ platforms such as Bettervest can and do support lending to, and investing in, green and sustainable projects that would be difficult or impossible for established lenders, however. This approach has multiple benefits for investors and investees, including cheaper and more flexible funding, increased engagement by potential customers and investors with green issues and solutions, and the capability of sharing risk with other investors across a potentially wide and diversified portfolio of investments. There have been concerns expressed, however, about the protection of investors in P2P and crowdfunding schemes, particularly if they involve complex projects and financial risks. Do retail investors genuinely understand the risks they are taking, and that their capital may be at risk if loans or investments default? Portfolios may be highly correlated and lack diversification, concentrating risks. Some financial regulators are considering how best to balance support for innovative approaches to delivering financial services with investor protection, which raises questions about how far and how fast these approaches should be scaled up, including in the area of green and sustainable finance.

Corporate banking and capital markets In earlier chapters, we examined how financial institutions and others can use advanced data analytics to help better identify, assess, manage, price and disclose climate-related and other sustainability risks, with the emphasis very much on identification at present. In addition, analytics can be used to monitor and verify the achievement of desired project outcomes and impacts (for example, when assessing the impact of green bonds or sustainability-linked corporate loans). The increasing availability and ability to analyse both structured and unstructured data play an important role in encouraging the further development of the green and sustainable finance sector by aiding transparency and disclosure, which helps prevent greenwashing and supports investor confidence and market integrity. The Green Digital Finance Alliance’s ‘Green FinTech Taxonomy’ introduced above gives examples of some of the most widely used datasets used in this area.14 Data can be – and are – used by environmental NGOs and others to identify instances of greenwashing by financial institutions, too. A good example of how FinTech tools and techniques can be used to support the development of capital markets is the Green Assets Wallet initiative, described in the following case study.

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CASE STUDY Green Assets Wallet15 The Green Assets Wallet (GAW) initiative describes itself as a ‘global trust platform to support capital markets to finance a credible sustainability transition’. It enables investors to access reliable data on environmental performance to support investment decision making, monitoring and reporting. GAW is independent, global and market neutral. GAW aims to support the growing market for debt instruments linked to environmental performance (such as green bonds) by bridging investors with potential investment opportunities through cost-efficient and immutable validation and reporting of environmental objectives and impact. To do this, GAW uses a blockchain-based platform developed by ChromaWay and supported by other partners, including the climate research institute and data provider CICERO. It automates datafeeds from institutions such as central banks, financial institutions, energy providers, transport operators and municipalities, and provides validated evidence of environmental impact from a wide range of sources, including satellite images, engineering reports, audit reports and electricity generation data. This enables investors to access (both pre- and post-issuance, and at the project level) trusted and verified best-in-class metrics with relevant KPIs and benchmarking, bringing transparency and building trust in the integrity of the green debt market.

FinTech tools and techniques, such as digital platforms and blockchains (distributed ledgers), can also reduce the cost and complexity of accessing capital markets, making it easier for smaller businesses and projects to issue, for example, green bonds or other securities. Given the challenges of identifying green and sustainable finance projects of sufficient scale to be financed by ‘traditional’ means, due in large part to the costs of issue, if technology can support smaller-scale capital market issuances, this may help to accelerate the growth of green finance. As evidenced in the following short case study, the use of blockchain technology enabled a €35 million green bond to be issued – well below the more common €0.5 to €1 billion benchmark issues.

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CASE STUDY BBVA issues blockchain-supported green bond16 In 2019, BBVA issued a six-year, €35 million structured green bond via a private placement with MAPFRE, a Spanish insurer, using an in-house, private blockchain platform. The platform allows clients to choose between numerous product configuration options in an entirely digital process in which the negotiation of the structure and prices, and the creation of documentation for the bond, are part of the same tool. This reduces the cost, time and complexity of creating securities, and also ensures that agreements are fully traceable and immutable. Juan Garat, BBVA’s Head of Global Sales states: ‘With this deal, BBVA reasserts its firm commitment to both sustainable financing and new technologies. Using DLT – distributed ledger technology – for this transaction allowed us to simplify the processes and streamline the negotiation time frames, which is in line with our pursuit of excellence in customer service.’ According to BBVA, the use of the blockchain platform offers the following advantages: ●●

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‘It allows all participants to have access to the transaction.’ Distributed ledger technology reduces issuing time and ensures that the negotiations and agreements reached are traceable and immutable. These features of traceability and immutability make it easier to demonstrate compliance with the relevant regulations. The platform allows clients to ‘choose between numerous product configuration options’. This gives clients considerable flexibility in terms of designing the bond that best suits their needs. It works for products from the simplest to the most complex. This enables a ‘selfservice approach’ in which investors who know what product they want to invest in can save time and effort by limiting the definition of the different variables. Investors looking for new investment solutions can quickly and easily explore new products. It is an ‘entirely digital process’ in which the negotiation of the structure and prices, and the creation of documentation for the bond, are part of the same tool.

QUICK QUESTION Thinking about the organization you work for, or a financial institution you are familiar with, can you identify any examples of FinTech tools and techniques being deployed to support environmental or other sustainability objectives?

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Investment In addition to enabling retail investors to participate directly in investment in and lending to green activities and projects, FinTech tools and techniques may support investment in green and sustainable activities, firms and projects more generally. In particular, and as we have explored in earlier chapters, the increasing availability and granularity of structured and unstructured data relating to sustainability factors, improvements in data quality, standardization and verification, and advances in AI and machine learning applied to data analysis can support the continued growth of sustainable investment. The ever-increasing availability of data creates challenges as well as benefits for investors and analysts, however, as it becomes more difficult to separate truly meaningful and useful data that can provide insights into financial and sustainability performance from ‘noise’. A number of technology-driven data analytics and ratings firms have been established and have grown rapidly in recent years, including Climetrics and Sustainalytics (introduced in Chapter  9), TruValue Labs and Arabesque.

CASE STUDY Arabesque S-Ray®17 Arabesque S-Ray® is a proprietary tool that allows investors and others to monitor the sustainability of over 8,000 of the world’s largest corporations. Using machine learning and big data, Arabesque S-Ray® systematically combines over 200 environmental, social and governance (ESG) metrics with news signals from over 30,000 sources across 20 languages and 170 countries. This empowers investors and other stakeholders to make better decisions for a more sustainable future. It is the first tool of its kind to rate companies using the normative principles of the United Nations Global Compact (GC Score). Additionally, Arabesque S-Ray® provides an industry-specific assessment of companies’ performance on financially material sustainability criteria (ESG Score), and a Temperature Score that evaluates companies’ contribution to global warming. Scores are combined with a preferences filter that allows users to better understand each company’s activities and impacts, and how these align with investors’ values and preferences. ESG Score Arabesque S-Ray® incorporates sector-specific assessments of company performance across financially material environmental, social and governance (ESG) issues. Each company is scored within the context of its industry environment, based on factors that have a material relationship with future financial

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performance. The result is a proprietary ESG score for each company, providing an assessment of long-term financial performance. GC Score Arabesque S-Ray® analyses companies based on the four core principles of the United Nations Global Compact (GC): human rights, labour rights, the environment and anti-corruption. With Arabesque S-Ray®, these principles are quantified for the first time, with the potential to inspire more companies to take shared responsibility and join the Global Compact in its commitment to achieve a sustainable and inclusive global economy. Temperature score The Temperature Score is a proprietary metric developed by Arabesque S-Ray® that quantifies the extent to which companies contribute to global warming through their greenhouse gas emissions. It does this by translating publicly disclosed emissions to a temperature score, based on sector-specific emissions pathways.

QUICK QUESTION Use the Arabesque S-Ray® tool to obtain ESG, GC and Temperature Scores for the organization you work for or a company you are interested in. What are they, and what does this imply about the organization’s alignment with sustainability goals?

The advantages to investors of advances in data availability and analysis include: ●●

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developing a more comprehensive view of a company’s/investment’s exposure to climate risks, environmental impact and sustainability more broadly by enabling multiple – perhaps hundreds – of structured and unstructured data sources to be utilized and compared, improving investment decision making; the growing availability of standardized data on environmental performance and sustainability, allowing different potential investments to be more easily and effectively compared; enabling real-time monitoring and verification of investment performance in terms of desired green and sustainable outcomes; for instance, monitoring emissions data, power usage or the sustainability of supply chains and helping investors manage investments more dynamically;

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using blockchain (distributed ledger) technology to validate and provide an immutable record of outcomes, as in the Green Assets Wallet initiative described in the previous section, and the World Wide Generation G17 Eco Platform described in the case study below; developing new sustainable investment funds, such as ESG index-tracking funds, as discussed in Chapter 9; and reducing the costs of investment analysis via automation, which is particularly important for active investment managers who are under pressure from the growth of lower-cost index tracking and other passive investment funds.

CASE STUDY World Wide Generation G17Eco Platform18 The World Wide Generation (WWG) G17Eco Platform is a blockchain-enabled platform that provides an interoperable, transparent marketplace for sustainable investing. It uses distributed ledger technology to automate the mapping, monitoring, measuring, managing and marketing of an organization’s contribution to the UN Sustainable Development Goals. Through this, it aims to ‘unlock trusted, comparable and real-time data and impact measurement to empower. . . decision making of where to invest, divest, manage risk and create effective sustainable solutions at scale.’ The Platform enables companies, governments, financial institutions, NGOs and others to ‘map, manage, monitor, measure and market their SDG initiatives from one blockchain-powered platform.’ This solves the transparency and trusted data challenge that has hindered the matching of the need for investment in sustainable activities and outcomes with investors seeking genuinely sustainable investments. To do this, WWG has developed and released two apps built on blockchain: The Company Tracker App – a digital monitoring, reporting and verification tool that streamlines and standardizes sustainability reporting. The Portfolio Tracker App – which enables investors to measure the alignment of their portfolios with globally recognized sustainability standards, frameworks and regulation.

QUICK QUESTION What data does your organization, or an organization with which you are familiar, provide that might help investors and analysts assess sustainability? Think beyond regulatory reporting data and consider other sources that could be used.

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Insurance In Chapter 10, we saw how FinTech tools and techniques have already been adopted in insurance in both developed and developing markets, including Pay as You Go (PAYG) insurance using telematics and smartphone apps to price and pay for insurance based on journeys taken and driving style, as well as blockchain/smart contract-based climate index insurance for farmers and smallholders. As major institutional investors, insurers can also benefit from the application of FinTech tools and techniques more generally. As risk managers, insurers can benefit from the increasing availability and granularity of data, and developments in data analytics. FinTech tools and techniques can be used to support impact underwriting in the developing world by providing access to insurance for communities particularly at risk from climate change and related extreme weather events, in order to enhance their climate resilience. In the case of products and services targeted at individuals, smallholders and small businesses in the developing world (referred to as ‘microinsurance’), the combination of lower cost and wider distribution, claims management via smartphones and index insurance linked to remote data monitoring and providing automatic pay-outs can support new, lower-cost models of insurance that also support financial inclusion. In the developing world, insurers such as aYo and BIMA partner with mobile phone providers to offer a range of insurance services to their customers, using existing distribution channels and also giving mobile providers an additional revenue stream.

CASE STUDY OKO: bringing crop insurance to emerging markets19 OKO is an Israeli InsurTech company supported by the Luxembourg Catapult: Inclusion Africa FinTech incubator and development programme. It combines new technologies in satellite imagery and weather forecasting to simplify and automate claims management and create low-cost crop insurance for smallholder farms, together with mobile distribution. Through insurance, OKO supports climate resilience, financial inclusion and job creation in sub-Saharan Africa. Index insurance product creation OKO partners with weather information providers, using satellite and microwave technologies to obtain hyper-local data that can be used to: ●●

define risk with high precision, and therefore optimize the premium price;

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automate the claim validation process through an analysis of the historical data.

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Distribution tools OKO creates innovative tools to distribute insurance in remote areas and to unbanked farmers: ●● ●●

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a USSD menu allowing policy management from any mobile device; a mobile app that provides a second-to-none customer experience, and is usable offline; an API that lets partners (micro-finance institutions, for example) access relevant information securely.

Working with the Fijian government and the Fiji Sugar Corporation, OKO has also developed a micro-insurance scheme offering farmers subsidized insurance against drought, floods and hurricanes. Ultra-localized weather monitoring and automated claims management means farmers can obtain insurance at low cost.

QUICK QUESTION How might FinTech-enabled micro-insurance principles be applied to promote green and sustainable finance outcomes in the developed world?

Cryptocurrencies (digital currencies) In addition to the application of FinTech tools and techniques in the retail and corporate banking, investment and insurance sectors, some commentators believe that cryptocurrencies can support the growth of green and sustainable finance and sustainable development in general. There are many different types of cryptocurrency (sometimes also referred to as ‘cryptoassets’), and it is beyond the scope of this book or course to look at these in detail, but in brief, a cryptocurrency uses blockchain (distributed ledger) technology to create a means of exchange for financial transactions without the need for a central issuing authority, such as a central bank. Well-known cryptocurrencies include Bitcoin, Ethereum and Ripple. As we mentioned earlier, some central banks are developing their own digital currencies, sometimes referred to as ‘GovCoins’. At the time of writing, there are approximately 10,000 active cryptocurrencies, with a total market value of approximately $900 billion (November 2022) – a very substantial contraction compared with more than $2 trillion the year before. High levels of volatility mean that many cryptocurrencies are used more for speculative

Green and sustainable FinTech

investment than as a means of exchange; the value of a Bitcoin grew from approximately $9,500 in January 2020 to more than $65,000 in August 2021, before falling back to less than $17,000 in November 2022. Volatility is a key characteristic of cryptocurrencies; because there is no central entity, the value of the digital currency ebbs and flows with market sentiment. Proponents of cryptocurrencies for growing green and sustainable finance suggest that decentralized blockchain and smart contract technologies, linked to the availability of environmental performance and sustainability data and supported by access to cryptocurrencies through digital wallets, can incentivize more sustainable consumer behaviour. We will look at an example of this in the case study below on SolarCoin, which aims to incentivize solar energy production. As has been widely reported, however, many cryptocurrencies, particularly those that rely on ‘mining’ to create new cryptoassets, require huge computing power and energy consumption to function. They can, therefore, have a substantial negative impact on the environment when they rely – as many do – on fossil fuels for power generation. The Cambridge Bitcoin Electricity Consumption Index tracks Bitcoin’s use of electricity; it estimates that, as of March 2022, Bitcoin mining requires some 126 terawatt hours of electricity annually – similar to the annual energy consumption of Norway.20 Whilst this does not mean that all Bitcoin mining is powered by fossil fuel-produced electricity, the index also shows where in the world mining takes place, with countries such as China (accounting for some two-thirds of Bitcoin mining until this was banned in 2021), Kazakhstan and Russia being some of the main locations for mining – these are all countries with highly carbon-intensive electricity generation sectors. It should be remembered, though, that the operations of banks and other financial institutions also require significant electrical power generation to support them, for example, to power offices and data centres, where that power may come from renewable or non-renewable sources. Some cryptocurrencies, however, such as SolarCoin, BitGreen and Impact Coin, are designed to be environmentally friendly and sustainable from the outset.

CASE STUDY SolarCoin21 SolarCoin is a cryptocurrency that aims to incentivize the production of solar energy by generating SolarCoins to reward solar energy generators. SolarCoins can then be traded like other cryptocurrencies (although the market is much smaller than for popular cryptocurrencies such as Bitcoin or Ethereum), or spent at businesses that accept them.

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The long-term aim is for the value of a SolarCoin to exceed the generation costs of solar energy. This event, dubbed by the SolarCoin Foundation as the ‘Solarity’, would effectively mean free energy for the solar energy generator, provided the coins could be exchanged or spent. In November 2021, the generation cost for solar energy was $10.40 per MWh, compared with the cost of a SolarCoin at $0.05 per MWh, i.e. approximately 1/500th of the energy generation cost.22 Despite the falling costs of solar energy, then, there is still a long way to go until the Solarity is reached. Unlike many popular cryptocurrencies, SolarCoin does not use mining to validate transactions and generate coins. The SolarCoin Foundation estimates that the project uses less energy than a single home, keeping greenhouse gas emissions and transaction costs very low. How it works Solar energy producers file a claim to register their solar installation via their monitoring system or platform. Claimants download an Ethereum-compatible wallet like Metamask to create a receiving address that acts like a bank account. The monitoring system sends generation to the SolarCoin Foundation, which in turn sends SolarCoins to the claimant’s wallet at a rate of 1 SolarCoin per 1 MWh of verified electricity production. Claimants can save, exchange or spend SolarCoins as they wish, and may receive ongoing grants over the next 20–30 years as they generate energy.

At present, however, ‘green’ cryptocurrencies are but a small niche in green and sustainable finance, and are unlikely to grow substantially without greater regulatory and economic certainty in the cryptocurrency/cryptoasset market. They also lack the speculative interest (and the high and volatile valuations) of the most popular cryptocurrencies such as Bitcoin. The blockchain, distributed ledger and smart contract technologies that underpin cryptocurrencies, though, have many wider applications in support of green and sustainable finance, as we explored earlier in this chapter.

QUICK QUESTION Look up the current market price of Solarcoin, or another ‘green’ cryptocurrency. How does it compare with the current market price of Bitcoin?

Green and sustainable FinTech

Policy and finance sector initiatives to support FinTech in green and sustainable finance National and international policymakers have recognized the potential of FinTech and digital finance to support a range of international and national policy goals relating to green and sustainable finance, including promoting the transition to a sustainable, low-carbon world, and increasing financial inclusion to enhance sustainable development and support the achievement of the UN Sustainable Development Goals. As we discussed earlier in this chapter, this includes using FinTech tools and techniques to develop and deploy products and services that support sustainable finance, as well as using them to better align finance overall with sustainable goals. Some of the key initiatives established by policymakers and the finance and technology sectors are introduced and outlined below.

International policy and sector initiatives UN Environment Programme (UNEP) In 2016, the UN Environment Programme (UNEP) published a key report on the use and potential of FinTech to support green and sustainable finance, which concluded that ‘FinTech offers the prospect of accelerating the integration of the financial and the real economy, enhancing opportunities for shaping greater decentralization in the transition to sustainable development’.23 The UNEP report argued that both FinTech and sustainable development have the same potential as drivers of change and impact, and can create new, sustainable business models. They may, therefore, be mutually reinforcing. Combining the IoT, blockchain technology and AI to enhance efficiency and distribution, reduce costs and increase access to finance for individuals and small businesses, particularly in the developing world, can accelerate the green and sustainable finance agenda.

UN Development Programme (UNDP) Introduced at the start of this chapter, the UN Development Programme (UNDP) Task Force on Digital Financing of the Sustainable Development Goals was formed in 2018 to consider and make recommendations as to how FinTech tools and techniques, and digital finance overall, could be utilized to finance the UN Sustainable Development Goals. The Task Force’s remit covered both public and private finance spheres. Members of the Task Force included representatives from central banks and governments, financial institutions, the FinTech sector and UN agencies. The Task Force published its final report, ‘People’s Money: Harnessing digitalisation to finance a sustainable future’, in August 2020, with its conclusions and recommendations shaped in part by the impacts of the Covid-19 pandemic.

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READING UNDP Task Force on Digital Financing of the Sustainable Development Goals24 The UN Secretary General established the Task Force on Digital Financing of the Sustainable Development Goals (SDGs) in 2018. Its mandate was to recommend and catalyse ways to harness digitalization in accelerating the financing of the UN Sustainable Development Goals (SDGs), including both the public and private finance sectors. The Task Force published its final report People’s Money: Harnessing digitalization to finance a sustainable future in August 2020; it was shaped in part by the impacts of the Covid-19 pandemic. The Task Force concluded and recommended that: 1 Mobilizing sufficient financing remains a major challenge in implementing the 2030 Agenda for Sustainable Development: The gap does not arise from a lack of financial resources. Financing is not aligned with the SDGs because of a lack of data and standards, misaligned incentives and regulations, and gaps and weaknesses in institutions and markets. Much is being done to overcome barriers to financing the SDGs, but we are still not on course. The current crisis deepens the shortfall, despite the exceptional level of public spending on stimuli and bailouts. 2 Digitalization will make a difference if it helps to overcome barriers to financing the SDGs: It can do this through the combined and directed impacts of its three, essential features. i. More and better data, which drive better accounting of SDG-related risks and impacts in financial product design, financial decisions by private and public financiers and enhanced accountability. For example, this can improve the use of environmental data and increase the consideration of climate change, biodiversity loss, pollution and disaster risks in financing decisions. ii. Reduced transaction and intermediation costs, which enable broader access to financial services for groups that were previously difficult and expensive to serve. For example, this can reduce the cost of cross-border transfers, loan origination and other financial services to individuals and businesses through automating processes such as credit scoring and identity validation. iii. Innovative digital business models for financing sustainability and responding to the growing demand by citizens concerned with SDG impacts. For example, this can underpin new business and market approaches that enhance circularity and facilitate shared and better use of capital, more distributed financing of infrastructure and wider access through innovative credit and payment approaches.

Green and sustainable FinTech

3 Digitalization’s transformational potential is to extend beyond financial inclusion in shaping a citizen-centric financial system: Citizens care about far more than financial returns, with those wider concerns collectively expressed in the SDGs. Digitalization can help citizens in directing the use of their money more effectively to achieve their financial and nonfinancial goals – by delivering the right information, improved access, greater accountability and smarter financial services. Citizens can become more engaged in financial decision making individually (as consumers, savers and investors), collectively (as pension and insurance policy holders, members of associations and communities) or as accounting agents (taxpayers and voters). 4 Digitalization is already enabling many individuals and small businesses to gain access to financial services: There are already early signs of broader dimensions of digitally enabled financing of the SDGs. 5 There are significant barriers to advancing digital financing, and a number of risks associated with its emergence: Barriers include gaps in digital infrastructure and skills, and backward-looking or slow-moving policy and regulation. Skills gaps, social norms and discrimination restrict women’s access to and use of mobile technology and digital finance. In addition, there are risks that, if unmitigated, could deepen the disconnect between finance and sustainable development. Digitalization opens new routes for breaches of identity data, embezzlement and fraud. It can intensify shorttermism, undermine long-term value creation and may widen inequalities. The Task Force identified five systemically important ‘catalytic opportunities’ where, in their view, the tools and techniques of digital finance could be used to align finance overall with the SDGs: a Channel domestic savings into development financing: Policymakers should form national coalitions with infrastructure, finance and payment platform businesses to build ‘low-cost- high-integrity’ digital financing solutions to enable micro-savers (including women and young people) to finance local, sustainable infrastructure. b Enhance financing for small and medium-sized enterprises (SMEs): Policymakers and regulators should encourage market innovation to develop SME lending and investment platforms that integrate sustainability criteria and client protections, and avoid algorithmic discrimination against women-owned businesses. c Digitize public financing and make public budgets and contracts transparent: Policymakers should make commitments and work with civil society and the

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private sector to increase the transparency of public finances and use open government data to pursue SDG priorities. d Embed the SDGs into decision making in financial markets: Regulators should set requirements for pension and insurance companies to consult policyholders on the use of funds and to publish stress tests of all material SDG-related risks and impacts. e Shape consumption decisions through improved information and choice architecture: Policymakers should work with industry and provide incentives to encourage and facilitate sustainable choices by consumers and develop digital markets for sustainable assets. To support the alignment of finance with the SDGs, the Task Force also recommended that the international governance of the digital finance sector needs to be enhanced so that environmental and social sustainability factors are included as regulation, frameworks and standards are developed.

Green Digital Finance Alliance The Green Digital Finance Alliance (GDFA),25 introduced earlier in this chapter in the context of its Green FinTech Taxonomy, was established as a partnership between the United Nations Environment Programme and Ant Financial, the Chinese payments and financial services provider behind AliPay and Ant Forest. Launched in 2017, the GDFA focuses on three areas: ●●

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Content: Improving the knowledge base through research and analysis of leading sustainable digital finance practice and potential. Community: Creating a network of FinTechs, financial players, policymakers and other stakeholders that collaborate and promote sustainable digital finance practices at national and international levels. Country: Supporting action at the country level to pilot innovative approaches and take successes to scale

In addition to the Green FinTech Taxonomy, the GDFA has established and catalysed three significant initiatives to date: ‘Making Oceans Count’ (which aims to improve understanding of ocean risks and stimulate the design of ocean-positive financial products and services); ‘FinTech for Biodiversity Challenge’ (which will map FinTech products and services that support biodiversity) and the ‘Every Action Counts’ coalition described in the case study below.

Green and sustainable FinTech

CASE STUDY Every Action Counts coalition26 A new partnership to harness the power of green consumer behaviours to enhance biodiversity and climate efforts has been launched – with some of the world’s leading digital platforms, financial institutions and consumer goods and services companies as launch members. The Every Action Counts (EAC) coalition is convened by the Green Digital Finance Alliance (GDFA) and funded by the Finance for Biodiversity (F4B) initiative of the MAVA Foundation. Launch members are: Ant Group (China), BBVA (Spain), BigPay (Malaysia), DANA (Indonesia), FNZ (UK), GCash (Philippines), Lazada Group (Singapore), Mastercard (US), MTN Group (a pan-African company headquartered in South Africa), Paytm (India), Rabobank (Netherlands), SANLAM (South Africa) and Telenor Microfinance Bank/Easypaisa (Pakistan). The EAC brings together a global network of digital, financial, e-commerce and consumer goods and services companies with experts in sustainability, and nature and biodiversity conservation. The new network will share best practices in encouraging individuals to take positive actions in daily life to create planetfriendly outcomes. Each coalition member will endeavour to pursue locally relevant approaches to driving sustainable consumer behaviours by advancing peoplecentric, tech-enabled and innovation-oriented engagement models. The coalition holds the potential to scale green action as a norm that is encouraged, recognized and rewarded, leveraging technology and innovation models. Examples of this work in practice include: ●●

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Philippines-based GCash Forest rewards app users who reduce their carbon footprint by planting trees in partnership with groups such as the WWF. Mastercard is uniting its global network of businesses and consumers in climate action through the Priceless Planet Coalition reforestation initiative. The company is also collaborating with partners to create innovative digital products that provide insights about the carbon impact of purchases and enable people to easily contribute to preserving the environment. Ant Forest, a green initiative on the Alipay platform, encourages users to adopt low-carbon activities in daily life, such as going to work by bus instead of by car, and paying utility bills online instead of offline. The initiative has enabled the planting of over 220 million trees in less than five years.

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The coalition aims to promote knowledge-sharing to inspire innovative green-tech solutions around the world, helping each payment platform and consumer goods company focus on the green behaviours most relevant to their audience.

FinTech4Good FinTech4Good is a global network (with a particular focus on China and the US) that aims to accelerate the development of FinTech through research, incubation, acceleration and investment.27 Three key areas are blockchain, big data/AI and crowd investing, and the network has developed a range of incubation, education acceleration programmes to identify and support innovative start-ups in these and other areas. The network focuses on smart jobs, sustainable housing and smart cities, and digital finance (which it describes as ‘green, sustainable and inclusive finance enabled by digital transformation’).

Climate Chain Coalition The Climate Chain Coalition (CCC) was launched in 2017 to ‘cooperatively support the application of distributed ledger technology and related digital solutions to addressing climate change’. As of 2022, the CCC had over 250 members from over 50 countries – mostly FinTech providers, plus relevant finance sector associations, partners and consultancies.28 The CCC provides a platform for sharing and facilitating the adoption of new ideas and approaches, and supporting good practice in applying blockchain technology to green and sustainable finance, in areas including renewable energy, agriculture and forestry. In particular, it aims to support collaboration between its members in the use of blockchain and other FinTech tools and techniques to (a) mobilize climate finance, and (b) improve the measurement, reporting and verification of environmental impact and performance.

QUICK QUESTION What initiatives to accelerate and support the use of FinTech tools and techniques in green and sustainable finance are you aware of in the jurisdiction(s) where you live and work?

Green and sustainable FinTech

National policy and sector initiatives At the national level, a wide range of initiatives have been launched in recent years to encourage the development of innovative FinTech-led approaches to green finance, including but by no means limited to the following examples. Sweden launched Stockholm Green Digital Finance (now called Stockholm Green FinTech) in 2017, building on an existing FinTech hub and incubator to direct greater focus towards and accelerate green finance and investments by applying FinTech tools and techniques.29 Among the first projects incubated were a blockchain-based application (‘Climate KIC’) to help investors monitor and verify sustainable investments, and the Green Assets Wallet described earlier in this chapter. In 2018, the SDG FinTech Initiative was launched in Frankfurt, Germany, bringing together green and sustainable finance start-ups and Frankfurt Main Finance (the financial services trade association for Frankfurt), with the aim of combining topdown approaches by policymakers, regulators and others with bottom-up approaches from FinTech start-ups.30 The initiative has developed a network of NGOs, development organizations, larger financial institutions, policymakers and FinTech start-ups to share good practice, facilitate knowledge-sharing and strengthen links between individuals and organizations working in green and sustainable finance. In China, the Research Center for Green Economy and Sustainable Development at Tsinghua University was established in 2018.31 In 2020, a joint report with the Paulson Institute Green Finance Center was published: FinTech Facilitates the Sustainable Development of Green Finance in China.32 The report concludes that China’s green finance market has considerable potential for further growth but faces barriers including a lack of harmonized standards, challenges in measuring and reporting the environmental performance of investments and limited access to finance for many SMEs. The application of FinTech tools and techniques by both new startups and incumbent financial institutions can help overcome these challenges. The report also features a number of case studies demonstrating how some institutions are already using FinTech to advance green and sustainable finance in China. In 2018, the UK Financial Conduct Authority (FCA) launched a ‘Green FinTech Challenge’ to support innovation and growth in the green finance sector, aimed primarily at start-up and early-stage firms that would benefit from regulatory support to develop new products and services and bring them to market. Successful firms would benefit from support from the FCA ‘Innovate’ unit, which would provide guidance on authorization and live market testing in the FCA Sandbox (an environment that allows new approaches to be tested in controlled conditions). Nine firms were selected, including Cogo, introduced earlier in this chapter, which, with assistance from the FCA Challenge and elsewhere, has progressed from an early-stage start-up to a fully established firm with a carbon tracking product now adopted by several

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financial institutions. A second Green FinTech Challenge was launched by the FCA in 2021, with 10 firms selected from 25 applicants.33 The Monetary Authority of Singapore (MAS) established a FinTech Innovation Challenge in 2016, and in 2020 called for submissions that addressed the challenges of climate and other aspects of sustainability. It received more than 600 entries from 50 countries. In December 2020, the MAS launched Project Greenprint to develop a green FinTech ecosystem for Singapore that would position the country as a launchpad for other green FinTech initiatives and strengthen the country’s position as a leading green finance centre. Project Greenprint focuses on three key elements: ●●

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Mobilizing capital – recognizing that FinTech firms, and SMEs more generally working in the area of sustainability, can struggle to access capital. ­ onitoring commitment – developing data-driven solutions throughout supply M chains to monitor the environmental and sustainability performance of investments. Measuring impact – helping investors and financial institutions quantify and measure impacts against sustainability targets and goals.34

In Switzerland, the Green FinTech Network was convened by the Federal Government in 2020, with a mandate to identify areas in which the conditions for the sector in Switzerland could be improved. In April 2021, the Network published its report, presenting its vision for 2030 for Swiss green digital finance, along with 16 recommendations to support that vision. The recommendations were grouped in five areas: (a) foster access to data, (b) cultivate new start-ups, (c) promote access to clients, (d) ease access to capital and (e) boost the ecosystem and innovation.35

Costs and challenges of FinTech As we have discussed, the application of FinTech tools and techniques to the green and sustainable finance sector can both accelerate its growth and help align finance more generally with sustainable objectives. There are costs and challenges associated with FinTech from an environmental and sustainability perspective, however. As is the case with many technologies, FinTech is neither good nor bad in itself. FinTech tools and techniques may be applied to support positive outcomes for customers, communities and society overall, or deliver negative outcomes, either intentionally or unintentionally. Green and Sustainable Finance Professionals should, therefore, be aware of FinTech’s advantages and disadvantages when working with or advising customers or colleagues on its potential to support green and sustainable finance. One of the key criticisms of the FinTech sector, and in particular of cryptocurrency mining, is its increasing energy consumption and associated greenhouse gas

Green and sustainable FinTech

emissions, which we explored in 11.2.5 above. As we saw, Bitcoin mining alone is currently estimated to require some 126 terawatt hours of electricity annually – more than a medium-sized European country – much of which currently comes from nonrenewable sources. More generally, however, the increasing use of digital technology requires building infrastructure – particularly the data centres required to support cloud computing, which need electricity for power and air conditioning. According to Greenpeace, in 2020 Amazon’s data centres emitted more than 44 million tonnes CO2e; Microsoft emitted some 16 million tonnes CO2e.36 Data centres can, of course, be powered from renewables; Greenpeace also gives the example of Google’s longterm objective of purchasing all electricity from renewable sources, with 2020 CO2e emissions of only 1.2 million tonnes. This is not necessarily a criticism of FinTech alone, however, as existing financial institutions (and, indeed, organizations of all types) rely on increasing amounts of computing power and/or outsource this to cloud computing providers. They also require electricity to heat, light and cool offices. In addition, many incumbent organizations – at least pre-Covid – had significant carbon footprints generated by the travel of large numbers of employees both on business and when commuting to work. FinTech does not, therefore have to be more or less environmentally sustainable than ‘traditional’ finance; this depends, ultimately, on where and how the electricity needed to deliver digital finance is generated.

QUICK QUESTION Beyond environmental issues, what might be some other potential costs and challenges, from a social sustainability perspective, of utilizing FinTech tools and techniques in green finance?

The potential costs and challenges of adopting FinTech tools and techniques that may have a negative impact on social sustainability include: ●●

Digital exclusion: The adoption of FinTech products and services requires individuals to own, or have access to, internet-enabled digital terminals, typically smartphones. In 2021, 48 per cent of the world’s population were estimated to own a smartphone, but this was only 15 per cent for individuals in Pakistan and Nigeria, for example.37 Ownership is predicted to rise, and communities often share phones, but this still means that for many of the individuals in the developing world green and sustainable finance products and services are inaccessible, or at best are only accessible infrequently. Other factors, such as access to the internet itself, may make it difficult or impossible to use products and services.

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Difficulty in supporting vulnerable customers: Some groups of vulnerable customers (such as the elderly, or individuals with learning difficulties or other disabilities) may find it hard to use digital technologies to access financial services. Where these services are only available via digital channels, customers can be unintentionally excluded from being able to use them (for example, from a green investment platform only available via smartphone and tablet). Granularity: The availability of big data and the use of advanced data analytics can ensure better pricing of risk at more detailed levels. Financial products and services, such as loans and insurance premiums, can now be priced for the individual or small community. This may be a significant issue if, for example, the use of individual-level data means that financial services providers are unwilling to offer products and services to individuals at an affordable price because of the lack of risk pooling and the ability to price risk individually. Some individuals and communities may become uninsurable or otherwise have restricted access to financial services – a serious issue if this hampers individuals’ or communities’ climate resilience. ­ nconscious bias in AI and machine learning: For AI-enabled systems to learn and U develop, they need to be trained with data sets. The decisions made by automated systems will depend, therefore, on the quality of the data provided and, if the data comes from existing, real-world scenarios, there is a risk that the data may contain unconscious biases. Credit scoring data, for example, may show that individuals living in certain locations are less likely to default on mortgages and other loans. An AI/machine learning system may correlate this with numerous factors, including ethnicity, but this may lead to outputs and decisions that discriminate for or against particular societal groups. Lack of transparency: While the use of advanced data analytics applied to structured and unstructured datasets can be used to enhance monitoring, verification and transparency in green and sustainable finance, as we have discussed in this and previous units, the use of AI and machine learning to analyse data can lead to a ‘black box’ scenario. This is where outcomes and decisions cannot be explained to those impacted by those decisions, which can lead to a loss of trust. Loss of data control and privacy: Many FinTech products and services are based on the availability and analysis of large datasets. A number of high-profile incidents have occurred of individuals’ data being used by technology companies for purposes that individuals had not consented to, and/or were unaware of (as occurred with Facebook/Cambridge Analytica), or of significant data losses (such as Experian). Without suitable data governance and control, data obtained for the purpose of supporting climate change mitigation, adaptation and other positive, desired sustainability outcomes might be used – intentionally or unintentionally – for other purposes.

Green and sustainable FinTech ●●

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Social costs: FinTech tools and techniques, and particularly increased automation, can lead to job losses and/or increased job insecurity, as evidenced, for example, in the decline of branch networks in financial services, particularly in developed markets. This can disrupt communities if access to banking and other services becomes more difficult for customers who are unable, or unwilling, to use digital channels. At the extreme, the replacement of large numbers of customer-facing and back-office processing jobs with automation has the potential to significantly disrupt the finance sector and communities dependent on it. Potential for greenwashing: The rapid growth of FinTech products and services supporting green and sustainable finance means there is an increasing risk of greenwashing, where the benefits of a new product are overstated to secure investment and/or grow market share.

Many of these costs and challenges are relevant to financial services in general, not only to the green and sustainable finance sector. Unconscious bias in AI and machine learning has already been experienced in the US mortgage market, for example, with evidence that Black and Latino borrowers are charged higher interest rates.38 In some areas, however, such as restricting access to climate insurance because of digital exclusion, or facilitating greenwashing, FinTech tools and techniques have the potential to detract from, rather than support, the development of green and sustainable finance. When advising on FinTech tools and techniques, then, Green and Sustainable Finance Professionals should take active steps to ensure that potential issues are identified early, disclosed and mitigated wherever possible.

Key concepts In this chapter, we considered: ●● ●●

●●

●●

what is meant by FinTech, and associated terms; how FinTech tools and techniques can support the growth of green and sustainable finance, and help align finance overall with the aims of the Paris Agreement, the UN Sustainable Development Goals and other sustainability objectives; the benefits to customers, communities, financial institutions and society of applying FinTech tools and techniques to support green and sustainable finance; and some of the challenges to using FinTech tools and techniques to support green and sustainable finance.

Now go back through this chapter and make sure you fully understand each point.

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Review Enabled by advances in digital technology and data science, FinTech (‘digital finance’) covers a wide range of tools and techniques, including, but not limited to, smartphones and banking apps, the Internet of Things (IoT), Application Programme Interfaces (APIs), distributed ledgers (blockchain), artificial intelligence (AI) and machine learning, and analysis of large and complex data sets. Whilst often associated with fast-growth start-ups, FinTech tools and techniques are also used by incumbent financial institutions and other organizations (such as mobile operators) that can deploy new financial products and services at scale. The application of FinTech tools and techniques can support the continued development of green and sustainable finance, and help align finance overall with the aims of the Paris Agreement, the UN Sustainable Development Goals and other sustainability objectives, by: ●●

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i­ncreasing the availability, quality and disclosure of sustainability-related data, which can be used to make improved assessments of climate and wider sustainability risks and opportunities; decentralizing and increasing access to services and markets, helping more customers, communities and institutions participate in and engage with green and sustainable finance, and finance overall; and lowering the costs, and increasing the speed and efficiency, of providing financial services, providing general social benefit.

These and other factors can support the development and delivery of green and sustainable finance in the retail and corporate banking, investment and insurance sectors. This includes both the development of new products and services designed to encourage and promote more sustainable consumption and behaviour, and the use of FinTech tools and techniques to enhance the environmental and sustainability credentials of existing financial markets, products and services. Supporters of cryptocurrencies argue that decentralized blockchain and smart contract technologies, when linked to the availability of environmental performance and sustainability data, can incentivize more sustainable consumer behaviour. Whilst some cryptocurrencies are designed to be environmentally friendly and sustainable from the outset, many of the most popular cryptocurrencies, especially Bitcoin, require huge computing power and energy consumption to support mining. Where this comes from non-renewable sources, this is a significant source of greenhouse gas emissions. National and international policymakers have recognized the potential of FinTech tools and techniques to support policy goals relating to green and sustainable finance,

Green and sustainable FinTech

including promoting the transition to a sustainable, low-carbon world, increasing financial inclusion to enhance sustainable development and encouraging greater competition and innovation in financial services. This has led to an increasing range of policy initiatives designed to support the further growth of green and sustainable FinTech, and to align finance with sustainability goals. Whilst the adoption of FinTech tools and techniques is generally positive for green and sustainable finance, Green and Sustainable Finance Professionals need to be aware that there are also some negative aspects and consequences of the use of FinTech. These include the high energy costs of cryptocurrency mining and powering data centres; the potential for digital exclusion and/or a lack of access to financial products and services due to granular pricing; and the risk of greenwashing.

Table 11.1  Key terms Term

Definition

Artificial intelligence (AI)

The simulation of human intelligence by a computer or machine.

Blockchain/ distributed ledger

A database of records or transactions that are shared among participating parties, and verified by consensus of the majority of those parties – there is no central intermediary managing the database. Blockchains may be open access or private with limited access.

CleanTech

A term to encompass a wide range of technologies supporting environmental management, climate change mitigation and adaptation, and other related areas. Also referred to as ‘GreenTech’.

Crowdfunding/ crowdinvesting

Raising small amounts of capital from a large number of investors to finance projects or new business ventures, typically via the internet.

Cryptocurrency

A digital asset used as a means of exchange for financial transactions without a central issuing authority, generally using blockchain (distributed ledger) technology.

FinTech

A term combining Finance and Technology. Enabled by advances in digital technology and data science, it includes a wide range of tools and techniques, including, but not limited to, smartphones and banking apps, the Internet of Things (IoT), Application Programme Interfaces (APIs), distributed ledgers (blockchain), artificial intelligence (AI) and machine learning, and big data and data analytics. Also referred to as ‘digital finance’.

Humanitarian blockchain

Using distributed ledger technology to support humanitarian projects; for example, disbursing emergency funds for disaster relief or to refugees. (continued)

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Table 11.1  (Continued) Term

Definition

Internet of Things (IoT)

Connecting objects and devices to the internet with a sensor allowing the sending and receiving of data.

Machine learning

A form of artificial intelligence (AI) that enables systems to learn and improve from experience without being explicitly programmed. Machine learning encompasses a variety of techniques; most involve the use of large quantities of data for pattern recognition and inference to train the system.

Peer-to-peer (P2P) lending

Lending to individuals, businesses or projects via an online marketplace that matches lenders and borrowers.

Regulatory sandbox

A regulatory environment that allows new approaches to be tested in controlled conditions.

Smart contract

A self-executing contract between parties where the terms of the agreement are expressed and run as computer code, usually utilizing blockchain/distributed ledger technology to provide verification and ensure trust without the need for a central, legal authority.

Notes 1 UNDP (2020) People’s Money: Harnessing digitalization to finance a sustainable future, https://unsdg.un.org/resources/peoples-money-harnessing-digitalization-finance-sustaina​ ble-future (archived at https://perma.cc/TD58-5P8U) 2 KPMG (2021) VC Investment in fintech more than doubles in second half of 2020 – expected to remain strong into 2021, https://home.kpmg/xx/en/home/media/pressreleases/2021/02/vc-investment-in-fintech-more-than-doubles-in-second-half-of-2020.html (archived at https://perma.cc/W5MS-DJTN) 3 GDFA (2021) The World’s First Green Fintech Taxonomy, https://greendigitalfinancealli​ ance.org/a-green-fintech-taxonomy-and-data-landscaping/ (archived at https://perma.cc/ ND2F-C46D) 4 Vavrova, K (2020) A carefully calculated approach to climate change, https://vacuum​labs. com/blog/fintech/a-carefully-calculated-approach-to-climate-change (archived at https:// perma.cc/3MW2-XEK2) 5 Cogo (2022) Home, https://www.cogo.co (archived at https://perma.cc/KG65-2ZF3) 6 Pollock, D (2020) Blockchain for good: How the United Nations is looking to leverage technology, https://www.forbes.com/sites/darrynpollock/2020/02/27/blockchain-for-goodhow-the-united-nations-is-looking-to-leverage-technology/?sh=586f02a3543d (archived at https://perma.cc/F5MU-E9DE) 7 hiveonline (2021) Home, https://www.hivenetwork.online/ (archived at https://perma.cc/ WV7F-KZJT)

Green and sustainable FinTech 8 GreenTech Festival (2022) Home, https://greentechfestival.com (archived at https:// perma.cc/5JES-2JAH) ­9 UNDP (2020) People’s money: harnessing digitalization to finance a sustainable future, https://unsdg.un.org/resources/peoples-money-harnessing​-digitalization​-financesustainable-future (archived at https://perma.cc/TD58-5P8U) 10 Zadek, S (2017) Greening Digital Finance, available via the IISD SDG Knowledge Hub at http://sdg.iisd.org/commentary/guest-articles/greening-digital-finance/ (archived at https:// perma.cc/R6K4-97Q8) 11 Lewis, M (2014) Flash Boys, WW Norton 12 Nordea Bank (2020) Online and mobile services: Get insight into your CO2 footprint, https://www.nordea.fi/en/personal/our-services/online-mobile-services/co2-tracker.html (archived at https://perma.cc/3W6V-4K4F) 13 Bettervest (2022) About us, https://www.bettervest.com/en/about-bettervest/ (archived at https://perma.cc/N7Y5-Q7MW) 14 GDFA (2022) Green Fintech Classification, www.greendigitalfinancealliance.org/news-andevents/the-worlds-first-green-fintech-taxonomy (archived at https://perma.cc/6V54-G2VH) 15 Green Assets Wallet (2021) Home, https://greenassetswallet.org (archived at https:// perma.cc/3JPG-VAQW) 16 Martinez Farina, P (2019) BBVA issues the first blockchain-supported structured green bond for MAPFRE, BBVA, https://www.bbva.com/en/bbva-issues-the-first-blockchainsupported-structured-green-bond-for-mapfre/ (archived at https://perma.cc/JY77-2W7H) 17 Arabesque (now known as ESG Book) (2021/22) https://www.arabesque.com/s-ray/ (archived at https://perma.cc/7AXU-EQL4) 18 World Wide Generation (2022) Home, https://www.worldwidegeneration.co (archived at https://perma.cc/HW99-SVVP) 19 OKO Crop Assurance (2022) Home, https://www.oko.finance/ (archived at https:// perma.cc/A5F5-WPG8) 20 UOC: Cambridge Centre for Alternative Finance (2022) Cambridge Bitcoin Electricity Consumption Index, https://cbeci.org (archived at https://perma.cc/CR84-Z2UD) 21 SolarCoin (2022) Home, https://solarcoin.org (archived at https://perma.cc/L9ED-4TH9) 22 Gogerty, N (2022) Tracking the solarity: The path to free solar energy, https://grid.is/@ ngogerty/tracking-the-solarity-the-path-to-free-solar-energy-rsV0fdoSS_exikHvaUSjUA (archived at https://perma.cc/7NDM-ZNQQ) 23 UNEP (2016) Report: Fintech and sustainable development: Asessing the implications, https://www.unep.org/resources/report/fintech-and-sustainable-development-assessingimplications (archived at https://perma.cc/LY87-3CU9) 24 UNDP (2020) People’s Money: Harnessing digitalisation to finance a sustainable future, https://unsdg.un.org/resources/peoples-money-harnessing-digitalization-finance​-sustainable-future (archived at https://perma.cc/TD58-5P8U) 25 Green Digital Finance Alliance (2022) Home, https://greendigitalfinancealliance.org (archived at https://perma.cc/49S2-GEQT)

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Green and Sustainable Finance ­26 GDFA (2021) Every Action Counts Coalition to empower 1 billion green digital champions, https://greendigitalfinancealliance.org/initiatives-publications/eac-coalition/ (archived at https://perma.cc/LC2Y-5R83) 27 FinTech4Good (2022) Home, https://www.fintech4good.co (archived at https://perma.cc/ GH6Y-HXNR) 28 Climate Chain Coalition (2022) Home, https://www.climatechaincoalition.io (archived at https://perma.cc/B853-MKS3) 29 Stockholm Green Fintech (2022) Home, https://stockholmgreenfin.tech (archived at https://perma.cc/7WNQ-RH8W) 30 FinTech Consult (2022) SDG FinTech Initiative: Germany, https://fintech-consult.com/ germany/sdg-fintech-initiative (archived at https://perma.cc/BD59-FE9A) 31 Research Center for Green Economy and Sustainable Development, Tsinghua University (2022) Home, www.sem.tsinghua.edu.cn/en/info/1328/7310.htm (archived at https:// perma.cc/CHL6-7PCR) 32 Paulson Institute Green Finance Center; Research Centre for Green Finance Development of Tsinghua University (2020) FinTech Facilitates the Sustainable Development of Green Finance in China, http://www.paulsoninstitute.org/wp-content/uploads/2020/09/Fintechreport_Final1.pdf (archived at https://perma.cc/23VR-XXCV) 33 Financial Conduct Authority (2022) Green FinTech Challenge 2021, https://www.fca.org. uk/firms/innovation/green-fintech-challenge (archived at https://perma.cc/R4HX-DEPK) 34 Bank for International Settlements (2020) Ravi Menon: FinTech for an inclusive society and a sustainable planet. Remarks by Mr Ravi Menon, Managing Director of the Monetary Authority of Singapore, at the Singapore FinTech Festival 2020, https://www. bis.org/review/r201210c.htm (archived at https://perma.cc/H88M-VCWA) 35 Green Fintech Network (2021) Harnessing the Power of Digital Finance for Sustainable Financial Markets, https://www.sif.admin.ch/sif/en/home/dokumentation/fokus/greenfintech-action-plan.html (archived at https://perma.cc/3RCX-7EFX) 36 Jardim, E (2020) Microsoft, Google, Amazon – who’s the biggest climate hypocrite? https://www.greenpeace.org/usa/microsoft-google-amazon-energy-oil-ai-climate-hypo​ crite/ (archived at https://perma.cc/N3BX-E3WP) 37 Bankmycell (2022) How many smartphones are in the world?, https://www.bank​ mycell.com/blog/how-many-phones-are-in-the-world (archived at https://perma.cc/ NFV6-AC9H) 38 Public Affairs; UC Berkeley (2018) Mortgage algorithms perpetuate racial bias in lending, study finds, https://news.berkeley.edu/story_jump/mortgage-algorithms-perpetu​ ate-racial-bias-in-lending-study-finds/ (archived at https://perma.cc/3HLT-ZRTF)

12

T­ he future of green and sustainable finance Introduction This chapter revises some of the key themes covered in this book, considers the extent to which the finance sector has aligned its strategies, activities and operations with the objectives of the Paris Agreement and the UN Sustainable Development Goals, and explores what more needs to be done to make finance truly ‘sustainable’. We examine some of the barriers and challenges to embedding green and sustainable finance principles and practice across banking and finance, and how these may be overcome. In addition, we introduce two emerging areas of interest that Green and Sustainable Finance Professionals should be aware of – nature-based finance and ocean finance. Finally, we consider the role(s) individuals can play as Green and Sustainable Finance Professionals in embedding green and sustainable finance principles and practices within their professional activities, teams and organizations, and across finance as a whole, with the objective of ensuring that every professional financial decision takes climate change – and other environmental and social sustainability factors – into account.

L E A R N I N G OB J ECTI VES On completion of this final chapter, you will be able to: ●●

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Consider progress to date in aligning finance with the objectives of the Paris Agreement and the UN Sustainable Development Goals. Describe key challenges to the further growth of green and sustainable finance.

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Describe two key emerging areas of interest in green and sustainable finance – nature-based and ocean finance. ­ xplain the role of Green and Sustainable Finance Professionals, and what E individuals can do to promote and embed green and sustainable finance principles and practice. Develop a personal action plan for embedding the principles and practice of green and sustainable finance in your professional activities.

Progress in aligning finance with sustainability As we have seen throughout this book, finance plays a key role in addressing climate change and other environmental and social challenges. We have examined how aligning finance with the objectives of the Paris Agreement and the UN Sustainable Development Goals benefits the natural world and society. We have also seen how this can benefit financial institutions, too. When financial institutions develop and embed the expertise and cultures that enable them to identify, disclose and manage climate, environmental and sustainability risks, this enhances their organizational resilience – and that of the financial system overall. It also helps them identify and take advantage of opportunities to invest in the transition, and support customers’ and clients’ transitions as well. Supporting sustainable growth, resilience and prosperity – globally, nationally and locally – is good for finance, good for society and good for our planet. In addition, playing a proactive role in supporting (and, at times, leading) the transition to a sustainable, low-carbon world helps demonstrate a positive social purpose for the finance sector and profession. This can help reconnect finance and society, contributing to the process of rebuilding trust and confidence in financial services severely impaired during the Global Financial Crisis in 2008 and by other events. Aligning finance with sustainability, and mainstreaming green and sustainable finance must, ultimately, require green and sustainable finance principles and practices to be irreversibly adopted, implemented and embedded. It will not be sufficient for these to be adopted in small but growing niches within the finance sector, and in only some parts of the world. The threshold for success in terms of alignment is permanent adoption across the whole global financial system so that, as set out in the COP26 Private Finance Strategy, which we explore in more detail below, ‘Every professional financial decision takes climate change into account’ (and a wider range of environmental and social sustainability factors, too). Despite the significant progress that has already been made and the rapid growth of green and sustainable finance, this remains a distant but not unachievable objective at the current time.

The future of green and sustainable finance

As we have also seen throughout this book, finance has often harmed the environment and society through its lending, investment and underwriting activities, and still does in many areas. There is still much to do, therefore, to align finance and sustainability, and to mainstream green and sustainable finance principles and practice across our financial system. This requires international and national initiatives (many of which we introduced and examined earlier in this book), financial institutions and individual finance professionals to work together to embed green and sustainable finance principles and practice throughout finance, as we will see in this final chapter. First, we will look at progress in aligning finance with the objectives of the Paris Agreement, the UN Sustainable Development Goals and broader sustainability objectives. Then, in the next section, we will examine some of the barriers and challenges that prevent the continued growth of green and sustainable finance, and how these may be overcome.

Policy and regulatory developments to align finance with sustainability Throughout this book, we have introduced and explored many policy and regulatory initiatives and responses to climate change and broader environmental and social sustainability challenges. These have included policy and regulation at the global level (for example, the Paris Agreement), at the regional level (for example, the EU Green Deal and Sustainable Finance Action Plan) and at the national level. Also, as we explored in earlier chapters, policymakers, central banks and financial regulators have identified climate change and wider environmental and social sustainability factors as potential threats to institutional and overall financial stability, and so efforts to identify, disclose and manage these risks have become priorities in many jurisdictions, with global responses coordinated by bodies including the FSB and NGFS. From a policy and regulatory perspective, there has been very significant progress in many areas since the signing of the Paris Agreement in 2015. It is impossible to note or summarize all those covered in earlier chapters, but key developments include the following. At the global level: ●●

The publication in 2021 and 2022 of the IPCC’s most recent, comprehensive assessment of climate science (AR6, summarized and discussed in Chapter  2), which found that human activities were having unprecedented and irreversible effects on the global climate. Global warming is now assessed as being likely to rise under all scenarios by more than 1.5°C above pre-industrial levels by 2040 and by more than 2°C later in the century without dramatic and sustained reductions in greenhouse gas emissions.

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The evolution of global and national climate action via the UNFCCC COP26, held in Glasgow, Scotland in November 2021, which saw the first global stocktake of progress towards the objectives of the Paris Agreement since it was signed in 2015. Countries presented updated, more ambitious climate action plans for restricting global warming, and also agreed plans to address biodiversity loss, deforestation and other environmental harms. Updated Nationally Determined Contributions (NDCs) and other pledges made would not by themselves, however, lead to the dramatic and sustained reductions in greenhouse gas emissions required to meet the objectives of the Paris Agreement. The establishment in 2021 of the Glasgow Financial Alliance for Net Zero (GFANZ), which brings together over 450 financial firms responsible for assets of more than $130 trillion from the UN-convened Net-Zero Banking, Asset Owners and Insurance Alliances, plus the Net Zero Asset Managers Initiative, Net Zero Financial Services Providers Alliance, Net Zero Investment Consultants Initiative and Paris Aligned Investment Initiative. By bringing together this wide grouping of net zero finance initiatives in one sector-wide strategic forum, GFANZ will catalyse the strategic and technical coordination of the financial services sector globally to align lending, investment and other financing activities with the objectives of the Paris Agreement. The increasing impact of the Task Force for Climate-related Financial Disclosures (TCFD). Some 3,400 organizations (as of January 2022) now align their disclosures with the TCFD’s recommendations, including more than 60 of the world’s 100 largest public companies. As we saw in Chapter 5, a growing number of major jurisdictions, led by the UK, EU and other G7 nations are introducing mandatory TCFD-aligned disclosures, with other countries likely to follow.

At the regional level, in Chapter 3 and elsewhere we introduced the EU European Green Deal, Sustainable Finance Action Plan and related policy and regulatory activities. The European Green Deal, estimated to require investment of some €1 trillion over a 10-year period, aims to support a sustainable recovery from the Covid-19 pandemic via accelerating the EU’s green transition. The European Green Deal will be supported by the EU Taxonomy for Sustainable Activities and a range of further policy actions including the development of a Social Taxonomy, an EU Green Bond standard, new transparency and disclosure requirements, and retail investment labels. At the national level, three major developments are: ●●

China (the largest emitter of greenhouse gases) publishing its 14th Five-Year Plan, covering the period 2021–25. The plan sets legally binding targets to reduce emissions by 18 per cent in that period, and sets a target for China to become carbon neutral by 2060. As we saw in Chapter 4, China has also recently launched the world’s largest emissions trading scheme.

The future of green and sustainable finance ●●

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­ he United States (the second largest emitter of greenhouse gases) rejoining the T Paris Agreement. As a consequence, key regulatory bodies including the US Federal Reserve (‘The Fed’) and Securities and Exchange Commission (SEC) are beginning to take rapid action to ensure financial institutions identify, disclose and manage climate risks, as we outlined in Chapter 5. India (the third largest emitter of greenhouse gases) committing to achieving net zero emissions by 2070, including a more ambitious interim 2030 target of reducing emissions by 45 per cent from 2005 levels. New sustainability disclosure regulations are being introduced for listed companies, and the Reserve Bank of India (the central bank) has joined the Network for Greening the Financial System and is integrating climate-related risks into its supervisory activities.

In terms of financial policy and regulation, which we covered extensively in earlier chapters: ●●

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The Network for Greening the Financial System (NGFS) is playing a leading role in coordinating central banks’ and financial regulators’ approaches to identifying, disclosing and managing the climate risks faced by financial institutions. Having now grown to more than 100 members, the NGFS encompasses the majority of global emissions via the jurisdictions represented by its members, and works with many other international regulatory bodies to further harmonize global approaches. Central banks and financial regulators are beginning to have mandates revised and updated to include tackling climate change and ensuring environmental sustainability as well as financial stability. Examples include the Bank of England, PRA and FCA in the UK, and the European Central Bank, European Banking Authority, European Securities and Markets Authority and European Insurance and Occupational Pensions Authority, which are aligning their mandates and work programmes to support the European Green Deal, and sustainability more broadly. A wide variety of national taxonomies, green and sustainable bond frameworks and other policy tools (many examples of which we have seen in this book, most notably the EU Taxonomy) have been developed and implemented to ensure market integrity and support the continued growth of green and sustainable finance. In addition to regulatory and supervisory activity focused on climate risks, national regulators such as BaFin in Germany and the UK’s FCA are developing regulatory tools and guidance to identify and prevent greenwashing and mis-selling, particularly in the retail investment market. The European Commission’s Sustainable Finance Disclosures Regulation (SFDR), which aims to prevent greenwashing by introducing new transparency and disclosure requirements for financial firms providing or advising on investment and mutual funds, UCITS and pensions, is perhaps the best-known example of such regulation to date.

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With policy and regulation key drivers of financial services firms’ strategies, capital allocation decisions, activities and operations, the increasing alignment and clear direction of these – globally, regionally, nationally and in terms of the financial sector – provides a firm foundation for the continued growth of green and sustainable finance. As will be clear from this book, the pace of policy and regulatory development is extremely rapid, and is likely to continue to accelerate. Green and Sustainable Finance Professionals should, therefore, do all they can to keep up to date with general policy and regulatory developments, and in particular with those developments that impact their professional practice.

QUICK QUESTION What recent (or forthcoming) policy and regulatory developments are you aware of in the country/market(s) where you live and work?

Market developments evidencing the growth of green and sustainable finance Aligning finance with sustainability implies the growth of green and sustainable finance markets, and we have seen evidence of this throughout this book and course. For example: ●●

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The green and sustainable bond market continues to grow and develop. As we saw in Chapter 7, total green bond issuance now exceeds $1.5 trillion, with record annual issuance of green bonds in 2021 of some $523 billion. Total global sustainable investment now exceeds $35 trillion of assets under management, as we noted in Chapter  9, and accounts for more than a third of total global assets under management. Multilateral development banks (and national development and green development banks) are increasingly aligning their strategies and financing activities to support environmentally and socially sustainable sectors, projects and activities, as we saw in Chapter  8. Development banks play key roles in new market and product development, and in unlocking private finance through ‘blended finance’ approaches. Market standards, frameworks and guidance to strengthen market integrity and support the growth of green and sustainable finance market segments and products are becoming more widespread, and more firmly embedded. We introduced

The future of green and sustainable finance

a wide range of these in earlier chapters, including, but not limited to, the Green Bond, Social Bond and Sustainability Linked Bond Principles, and the Green Loan and Sustainability Linked Loan Principles. ●●

FinTech and digital finance tools and techniques are being used in retail and corporate banking markets, in investment and in insurance to align finance with sustainability, and to incentivize and support more sustainable consumption and behaviours, as we discussed in Chapter 11.

As we explored in earlier chapters, there are many drivers of the growth of green and sustainable finance markets, including: ●●

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the development of policy and regulation to address climate change, other environmental and sustainability challenges, and to align finance with the objectives of the Paris Agreement and other sustainability goals; an increasing understanding of climate, environmental and broader sustainability risks – and of opportunities that stem from supporting the transition to a more sustainable, low-carbon world; increasing evidence of at least average and possibly above-market returns from sustainable investments and sustainable investment strategies, as we discussed in Chapter 9; and changing demographics and evolving consumer, investor (and investment manager) values, preferences and behaviours.

We must continue to bear in mind, however, and have emphasized throughout this book, that despite very substantial growth in green and sustainable finance since the signing of the Paris Agreement in 2015, there is still a long way to go before it can be considered mainstream, that is, a core part of all financial services everywhere. Fossil fuel financing outweighs the financing of alternatives, for example, and global markets overall hold portfolios aligned with well above 3°C of global warming. There remains a great deal of inertia and embedded practice to overcome. Whilst policy and regulation can and do unlock sustainable finance, ultimately it will be the growing understanding and appreciation of the commercial opportunities from financing and supporting the transition to a more sustainable, low-carbon world that brings green and sustainable finance into the mainstream of finance overall. We saw in Chapter  1 that, while estimates vary, approximately $6 trillion per year is required to support the transition to net zero over the next 20–30 years. The global economic transition will be the most capital-intensive in human history and – if we are to keep global warming below 2°C and as close to 1.5°C above preindustrial levels as possible – it will require a rapid deployment of capital to support

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the development of a sustainable, low-carbon global economy within three decades. We have seen that public funds are insufficient, by a considerable margin, to finance the transition, and it estimated that up to 80 per cent of the capital required will need to come from private sector finance. The transition to net zero also involves a fundamental economic change, a shift away from generally opex-based systems (characterized by relatively low upfront capital costs followed by high variable resource input costs) to capex-based ones (with relatively high upfront capital costs followed by low marginal costs). Examples include investments in offshore wind farms (expensive to construct, but then the wind – at least in theory – blows for free) and retrofit mortgages (the costs of installing heat pumps and insulation are offset by lower ongoing heating bills). For the transition to succeed, the availability of substantial amounts of low-cost capital, particularly for low-carbon infrastructure and technology, and to support sectors’ and firms’ transitions to low-carbon business models, is essential. This can generate substantial commercial opportunities for lenders, investors and underwriters able to assess the risks and opportunities involved and make capital available. Mobilizing capital to support the transition is the role of the finance sector, as set out in Article 2.1 (c) of the Paris Agreement – connecting lenders and investors with projects and other investment opportunities that deliver both financial returns and positive environmental or other sustainable impacts. As green and sustainable finance markets grow and develop, capital will become increasingly aligned with sustainable objectives, and the finance sector increasingly aligned with sustainability.

QUICK QUESTION What recent green and sustainable market developments are you aware of in the country/market(s) where you live and work? Is there a national organization that tracks these?

Finance sector developments to align finance with sustainability and support the growth of green and sustainable finance In addition to the policy, regulatory and market developments highlighted in the previous sections, further evidence of the alignment of finance with sustainability comes from the growth in the size and impact of key finance sector alliances and initiatives, many of which we introduced and examined in earlier chapters. Major

The future of green and sustainable finance

alliances and initiatives that Green and Sustainable Finance Professionals should be aware of, and follow, include: ●●

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the Principles for Responsible Investment, which, as we saw in Chapter  9, now comprises more than 4,600 signatories from the investment community representing more than $100 trillion in assets under management;1 the Principles for Responsible Banking, which, as noted in Chapter 6, have now been adopted by more than 300 banks representing approximately 45 per cent of global banking assets under management;2 the Principles for Sustainable Insurance, which, as we saw in Chapter 10, have been adopted by more than 140 organizations representing approximately 25 per cent of world premium volume;3 the Glasgow Financial Alliance for Net Zero (GFANZ), which, as we described in Chapter  3, brings together over 450 financial institutions with more than $130  trillion of assets under management, coordinating sectoral net zero initiatives including the Net Zero Banking Alliance, Net Zero Asset Owner Alliance, Net Zero Insurance Alliance and Net Zero Asset Manager Initiative;4 the International Network of Financial Centres for Sustainability (FC4S), introduced in Chapter 3, a collective of some 40 major financial centres representing more than 80 per cent of global equity markets working to achieve the objectives of the Paris Agreement and the UN Sustainable Development Goals;5 and Climate Action 100+, an alliance of more than 615 institutional investors who, as we examined in Chapter 3, engage systemically important greenhouse gas emitters to seek to improve governance on climate change, curb emissions and strengthen climate-related financial disclosures.6

The growth of and coordination within and often between these and other alliances and initiatives is certainly a sign of progress in aligning finance with sustainability, and the growth of green and sustainable finance. The fact that such alliances and initiatives exist, though, is also evidence that much more needs to be done to align finance with the objectives of the Paris Agreement and broader sustainability goals. A sense of proportion is also required. Whilst the growth and membership of the groups and initiatives outlined above and elsewhere in this book and course are impressive, we should remember that many financial institutions – and in some sectors, countries and regions the majority of them – are not members of these. This does not necessarily mean that such institutions are not aligning their strategies, operations and activities with sustainability, but it does indicate that there is still considerable progress needed until green and sustainable finance principles and practices are irreversibly adopted, and consistently implemented and embedded.

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QUICK QUESTION Which of these (or other) finance sector alliances and initiatives is your organization, or an organization you are familiar with, a member of?

Fully aligning finance with the objectives of the Paris Agreement – the COP26 Private Finance Strategy The objective of the COP26 Private Finance Strategy, developed by Mark Carney in his role as UN Special Envoy for Climate Action and Finance, is to ‘ensure every professional financial decision takes climate change into account’ – a goal and theme we have returned to on many occasions throughout this book. Only when this is the case – and when every professional financial decision takes not just climate change but also the wider aspects of environmental and social sustainability into account – will we be able to say that green and sustainable finance has been genuinely mainstreamed, and finance aligned with sustainability. (These broader aspects of sustainability are beyond the scope of the COP26 Private Finance Strategy, as it is focused on achieving the objectives of the Paris Agreement.) COP26 – the global climate summit held in Glasgow, Scotland in November 2021  – provided the first opportunity for a global stocktake of progress towards the objectives of the Paris Agreement since it was signed in 2015, with countries presenting updated, more ambitious climate action plans in the form of their nationally determined contributions (NDCs), including pledges from China and India to achieve net zero by 2060 and 2070, respectively. The main outcomes of COP26 were published in the Glasgow Climate Pact, which called on governments to enact stricter emissions reductions policies and to close gaps in the implementation of the Paris Agreement, including the ‘phasing down’ of coal-fired power generation.7 From a finance perspective, the Glasgow Climate Pact emphasized the need to accelerate the alignment of the finance sector (both public and private) and to mobilize climate finance from all sources to reach the levels needed to achieve the goals of the Paris Agreement. This requires the adoption and implementation of a global framework through which private finance can align its activities with the objectives of the Paris Agreement. The COP26 Private Finance Strategy, published in advance of the climate summit, aims to provide this. It focuses on four areas: reporting, risk management, returns and mobilization (which we have explored throughout this book), as set out in Figure 12.1 and explored in the reading that follows.

The future of green and sustainable finance

Figure 12.1  Overview of the COP26 Private Finance Strategy

Risk Management

Reporting

of climate-related financial risks and opportunities by companies in line with TCFD

Returns of physical and transitional risks from climate change

Financial institutions must be embedded through a framework to ensure every financial decision takes climate change into account

realized from the enormous commercial opportunities in the transition to net zero

Mobilization

of private finance for investment in developing and emerging economies through new market structures and public–private partnerships

SOURCE  Carney, M (2020) Building a Private Finance System for Net Zero – Priorities for Private Finance for COP26

READING COP26 Private Finance Strategy – Ensuring that every professional financial decision takes climate change into account8 COP26, held in Glasgow in November 2021 (delayed by 12 months because of the Covid-19 pandemic), was considered by many to be the most important global climate summit since COP21 in Paris in 2015. This was because at COP26 countries would assess progress on implementation of the Paris Agreement and announce updated Nationally Determined Contributions (NDCs) – their climate action plans – aligned with limiting global warming to below 2oC above pre-industrial levels, and as close to 1.5oC above pre-industrial levels as possible. This requires a whole economy transition, enabled by the private finance sector. Finance is critical to accelerating and smoothing the transition both by a) funding new business models, technologies, firms and sectors moving from high- to lowcarbon models and activities, and b) amplifying the effectiveness of government climate policies. This will require all banks, insurers and investors to reshape their strategies, lending and investment decisions, approaches to risk management and other activities. Public and blended finance will contribute to the funding of climate mitigation, adaptation and resilience activities, especially infrastructure. The private

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finance sector, though, will play the key role in helping companies of all sizes transition to more sustainable, low- or zero-carbon business models. To support the alignment of private finance with the objectives of the Paris Agreement, the COP26 Private Finance Strategy was published in advance of the summit. Developed by Mark Carney, former Governor of the Bank of England and now UN Special Envoy for Climate Action and Finance, this was intended not just a strategy for COP26, but rather a strategy and roadmap for the finance sector beyond COP26 to support a successful transition to net zero. The objective set for the private finance sector is, in Mark Carney’s words, simple: ‘Ensure that every professional financial decision takes climate change into account’. The Private Finance Strategy focuses on four key areas: ●●

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Reporting: enhancing financial institutions’ climate-related disclosures, aligned with the recommendations of the TCFD; Risk management: improving financial institutions’ measurement and management of climate-related financial risks; Returns: raising awareness of the investment opportunities that arise from the transition to net zero; Mobilization: increasing flows of private finance to emerging and developing economies.

QUICK QUESTION What is your organization doing to ensure that ‘every professional financial decision takes climate change into account’? What more do you think it could do, and where should it prioritize?

Challenges to the growth and mainstreaming of green and sustainable finance Despite undoubted progress in recent years, as outlined in the introduction to this chapter and throughout this book, finance overall is not at present aligned with the objectives of the Paris Agreement and the UN Sustainable Development Goals. As we saw in earlier chapters, bank financing for fossil fuels increased each year following

The future of green and sustainable finance

the signing of the Paris Agreement in 2015, only falling back slightly in 2020 and 2021. Whilst the green and sustainable bond market has grown rapidly, total issuance only comprises a small proportion, perhaps 3–5 per cent (depending on the definitions used) of total bond issuance. Investors and investment managers are adopting sustainable investment strategies and aligning portfolios and funds with ESG and other criteria, but there is growing doubt about the sustainable credentials of some funds, leading regulators to take action to prevent greenwashing and mis-selling, as we examined in Chapter 9. Overall, as we set out in Chapter 1, it is estimated that financial institutions’ portfolios are aligned with significantly more than 3°C of global warming above pre-industrial levels, rather than the below 2°C and ideally 1.5°C as required by the Paris Agreement. There is still a long way to go, therefore, until ‘every professional financial decision takes climate change into account’. There are a number of significant challenges to be overcome to mainstream green and sustainable finance, many of which we have explored throughout this book. These include: ●●

policy and regulatory challenges;

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capacity, capability and cultural challenges preventing and avoiding greenwashing.

We examine each in turn below.

Policy and regulatory challenges As we have explored in this book, there are many international and national policy and regulatory initiatives designed to improve the identification of climate and other sustainability risks, support the growth and integrity of green and sustainable finance markets, and encourage and incentivize financial institutions to align their strategies, activities and operations with sustainability. Despite this, and the efforts of bodies such as the NGFS in particular, the broader architecture of policy and regulation often does not support the alignment of finance (and economic activity in general) with the objectives of the Paris Agreement and other sustainable goals. For example, in terms of financial policy and regulation, current challenges include: ●●

existing bank and insurance capital requirements (Basel III and Solvency 2), which, as currently drafted, can restrict the flow of capital to green and sustainable projects due to relative capital weightings;

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the absence of a ‘green supporting factor’ for bank capital, or similar incentives for investors (including insurers) to hold sustainable assets – or the introduction of higher risk weightings for high carbon assets; the lack of uniform or harmonized taxonomies to support a common definition of, and approaches to, green and sustainable finance (and the inclusion for political reasons of some activities in taxonomies, such as gas-fired power generation, that many would consider to be unsustainable); and the lack of clear and consistent guidance for boards and investment managers on incorporating sustainability within fiduciary duty (as we discussed in Chapter 9).

Policy and regulatory challenges go beyond those in the financial arena, however, and many of the challenges to the growth of green and sustainable finance come from other areas of policy and regulation that impact on the willingness or ability of financial institutions to invest in projects and activities with sustainable outcomes and objectives. In general, financial markets and financial institutions require policy and regulatory stability, and when this is absent it becomes more difficult and expensive to lend and invest, particularly in the longer term. Changes in building codes, carbon taxes, emissions criteria, feed-in tariffs and subsidies for electric vehicles and renewable energy, to give just some examples, can affect the risk/return profile of a lending or investment decision. Uncertainty over the frequency and extent of changes to these and other policy and regulatory areas tends to increase risk and reduce the ability and willingness of institutions to deploy capital. Unfortunately, the reality in many countries is that, despite high-level political commitments to tackling climate change and other sustainable goals, a wide variety of economic, political and social factors lead to policy and regulatory changes on a frequent basis. An obvious example is the United States withdrawing from the Paris Agreement under President Trump and rejoining under President Biden. At a more prosaic level, many countries have seen subsidies for solar panels introduced, increased, decreased and removed. Given that many of the financing decisions required to support climate change mitigation and adaptation activities, and other sustainable objectives, require a longer-term time horizon, policy and regulatory uncertainty reduces the attractiveness of such investments relative to well-known, stable (but high carbon) alternatives. Financial institutions do factor this uncertainty into lending and investment decisions, but long-term policy and regulatory certainty would improve the viability of many projects and investments.

The future of green and sustainable finance

QUICK QUESTION What policy and regulatory challenges (in terms of financial regulation, or more broadly) are you aware of in the country/markets where you live and work?

Economic challenges The greatest economic challenge to mainstreaming green and sustainable finance is the lack of a realistic, global carbon price, although – as we saw in Chapter 5 – some countries and regions are now making progress in this area. As we saw in earlier chapters, the IMF estimates that a global carbon tax of $75 per ton would be required by 2030 to reduce emissions to a level consistent with 2°C of global warming – but the average emissions price as of June 2021 was only $3 per ton, and some 80 per cent of global emissions are not currently priced at all.9 Carbon pricing via carbon taxes, cap-andtrade schemes and credible carbon offsetting programmes, as explored in Chapter 5, creates incentives for organizations to invest in low-carbon technologies and transition to reduce carbon use and emissions. It also helps organizations price  – and hence quantify – climate-related risks and opportunities and make capital allocation and other strategic decisions that take the true costs of emissions (externalities) into account. The current price of carbon, however, means that capital is misallocated, high-carbon investments are favoured over low-carbon alternatives, externalities are under-priced and the growth of green and sustainable finance is slowed. The need to grow green and sustainable finance in the developing world, where many of the required climate change mitigation and adaptation activities need to take place, is a further economic challenge. Aligning finance with the objectives of the Paris Agreement in developed and mature financial markets alone will not be sufficient to support the transition to a sustainable, low-carbon world. Investment in the developing world is hampered by a number of factors, including a lack of developed financial markets and regulatory infrastructure, political instability (in some cases), and higher costs of capital and costs of doing business more generally. For the green and sustainable finance sector to grow in many developing countries, the finance sector itself must develop and grow, too. The UN Sustainable Development Goals provide a helpful framework for addressing the wider sustainability issues faced by the developing world in particular, but further substantial capital will be required to achieve these.

Lack of coordination and consistency In earlier chapters, we saw that governments, central banks and financial regulators are increasingly seeking to coordinate and harmonize approaches to addressing the

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identification and disclosure of climate and other sustainability risks, and to encourage the growth and integrity of green and sustainable finance through bodies such as the FSB and NGFS in areas that include: ●●

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requiring financial institutions and other large organizations to identify and disclose their exposure to climate and other sustainability risks (often aligned with the recommendations of the TCFD); conducting stress tests based on climate scenarios such as those developed by the NGFS; e­ nhancing financial institutions’ governance and management of climate and environmental risks; supporting the development and adoption of market standards, guidelines and frameworks such as the Green Bond and Green Loan Principles; and avoiding and preventing the mis-selling of investments (greenwashing) by developing criteria for describing and labelling funds and investments as ‘sustainable’ and/ or ‘ESG’.

Progress has undoubtedly been made, but can be over-stated. For example: ●●

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As we saw in Chapter 5, some 23,400 organizations (as of January 2022) have aligned their reporting with the TCFD’s recommendations, including more than 60 of the world’s 100 largest public companies. Some jurisdictions, including G7 members, are introducing mandatory TCFD disclosures for large companies, including financial institutions. This still means, though, that the very great majority of organizations do not report in line with the TCFD’s recommendations, or indeed report their exposure to climate risks at all (although these may be captured in disclosures to the extent that they form part of reporting organizations’ supply chains). Furthermore, many of the organizations that do currently report do not necessarily fully meet the TCFD’s requirements, particularly in terms of forwardlooking scenario analysis; this makes comparisons between organizations and over time difficult. In Chapter 4, we saw how the reporting of greenhouse gas emissions (particularly Scope  3, financed emissions) and broader sustainability impacts is fragmented, with a wide range of different bodies and methodologies involved. There are no standard regulatory requirements as there are (to a large extent) for financial reporting. As we discussed, the newly established International Sustainability Standards Board (ISSB) aims to standardize non-financial reporting, but it will take time to develop and apply standards globally, and some major jurisdictions – such as the United States – may choose to remain outside the remit of any new body, as is the case for with International Financial Reporting Standards.

The future of green and sustainable finance ●●

Despite the development of the EU Sustainable Finance Taxonomy and the importance of the European financial markets for green and sustainable finance, the Taxonomy does not seem likely to become a global standard. Other major financial markets, including China, the UK and the US, have developed or are in the process of developing their own taxonomies, which may be broadly similar in many respects but also contain important differences reflecting differing political, economic and societal choices.

The lack of coordination and consistency is a challenge to the global growth of green and sustainable finance as it increases the cost and complexity faced by financial institutions seeking to work globally. This is not just an issue for large global institutions, which may be used to dealing across multiple jurisdictions with different regulatory and legal requirements. It is also an issue for smaller, more specialist institutions, as many of the investments needed to support climate change mitigation and adaptation, and the UN Sustainable Development Goals more broadly, are required in parts of the world where regulation and standards differ considerably from those in domestic markets, creating a barrier to doing business. The lack of coordination and consistency goes beyond regulation and standards, however. Throughout this book we have introduced a wide range of banking, insurance and investor alliances, coalitions, initiatives and groupings aiming to align finance with the objectives of the Paris Agreement and the UN Sustainable Development Goals, and to encourage and support the growth of green and sustainable finance. The landscape can be confusing for individuals and institutions to navigate, and assessing progress in aligning finance with sustainable objectives can be difficult because there is often multiple and overlapping membership and reporting. The situation should be improved to some extent with the establishment of the UN-convened Net Zero Banking Alliance, Net Zero Asset Owner Alliance and Net Zero Asset Manager Initiative, now encompassed within the Glasgow Financial Alliance for Net Zero (GFANZ), introduced in Chapter  3. The UN Principles for Responsible Banking, Principles for Responsible Investment and Principles for Sustainable Insurance also bring a greater degree of consistency to their relevant sectors.

Data challenges We have explored issues of data availability, quality, consistency and comparability throughout this book. In the context of addressing climate and environmental risks and taking advantage of the opportunities from the transition to net zero, data challenges are often raised as one of the key barriers to the continued growth of green and sustainable finance. As we saw in Chapter 4, the UNFCCC Standing Committee

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on Finance and other bodies note that issues of data availability, comparability and quality create challenges for investors, regulators, policymakers and others seeking to monitor and report on both environmental impacts – and flows of climate finance, in particular. As we explored in that chapter, the wide range of different reporting standards, metrics and organizations for measuring and disclosing greenhouse gas emissions and other key sustainability data makes consistent and comparable reporting difficult. Without accurate, relevant, consistent and comparable data on the environmental and other sustainability impacts of lending and investment decisions, capital can be misallocated, climate and other sustainability risks mispriced (or not identified), and the risks of deliberate or inadvertent greenwashing heightened. It is not always a lack of data that is the greatest challenge, however. In earlier chapters we noted that environmental performance data, in particular, is becoming increasingly available due to developments in data collection from satellites and other climate/weather monitoring platforms, as well as from drones, remote sensors and smartphones. Both structured and unstructured data is increasingly available and utilized, and we looked at several examples of this in this book (such as Sustainalytics and Arabesque S-Ray®). Thus, there are other data challenges: ●●

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The ability to analyse and synthesize very large datasets, particularly unstructured data, so that environmental and other sustainability impacts and outcomes can be assessed, and meaningful insights to support capital allocation and decision making generated (that is, being able to ‘cut through the noise’). The costs of obtaining and analysing data – whilst institutions such as the World Bank, and many national governments, central banks and others make some useful data freely available, many data providers are commercial institutions that charge for access to and analysis of proprietary datasets. This limits access for smaller financial institutions, researchers and organizations, especially in the developing world. The multiplicity of proprietary data providers, making comparisons of environmental and sustainability performance over time and between institutions, projects and activities difficult or even impossible. The establishment of the new International Sustainability Standards Board (ISSB) and greater agreement on metrics and standardization of sustainability data should help to address this issue over time. Despite increasing harmonization around TCFD-aligned disclosures, many jurisdictions may have different rules and standards for data and disclosure in other areas that impact environmental and sustainability reporting (for example, relating to social factors). There is a relative lack of data from developing countries and emerging markets, where many of the climate mitigation, adaptation and other environmental and social projects and activities need to occur.

The future of green and sustainable finance

Overall, however, relevant climate and environmental datasets are more accessible than was previously the case. There has been significant growth in the number of data providers offering open source and/or proprietary structured and unstructured datasets, analysis and modelling. The falling cost of computing power and the development of advanced data analytics has also made data, and data analysis, more widely available. Environmental and sustainability performance data are increasingly embedded within financial institutions’ decision making, helping to align finance and sustainability.

Capacity, capability and culture challenges We have restated the objective of the COP26 Private Finance Strategy on many occasions throughout this book and course – to ‘ensure that every professional financial decision takes climate change into account’. As we have discussed, to make this a reality – and to incorporate broader sustainability factors beyond climate change into decision making in the finance sector – this requires every finance professional to develop at least a basic knowledge of the principles and practice of green and sustainable finance relevant to their role, function and organization. The objective is not to create a finance sector and profession comprised of sustainability specialists, although greater numbers of environmental and other sustainability specialists are undoubtedly required throughout finance. Rather, it is to build the capacity and capabilities of the finance sector and profession so that environmental and other sustainability factors are taken into account when formulating strategies, developing products and services, managing risk and advising and supporting customers and clients. Aligning finance and sustainability requires developing and sustaining strong, purposeful cultures within institutions, and within finance overall, aligned with the objectives of the Paris Agreement, the UN Sustainable Development Goals and sustainability overall. At present, however, even – perhaps especially – the largest financial institutions lack the capacity and capabilities required to achieve mid-century net zero commitments or the interim targets for 2030 or 2035, such as those made by members of the Glasgow Financial Alliance for Net Zero (GFANZ). Whilst the recruitment of staff with relevant sustainability expertise has increased considerably in recent years, they are still often grouped in central sustainability and/or ESG teams and the like rather than involved in day-to-day commercial, lending, investment and underwriting decisions, product and service design, or supporting and advising clients and customers. Front-line staff in financial institutions – those with key roles to play in customer and client engagement, working with households, companies and communities on their transitions to more sustainable, low-carbon models of production and consumption – are in many cases only just beginning to receive the education and training they need.

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Furthermore, similar issues of capacity, capability and culture apply to the wider professional community of accountants, actuaries, lawyers and others who support the activities of financial institutions and financial services professionals. Capacity and capability issues are particularly marked in the developing world and emerging markets. As we noted above and elsewhere in this book, capital and financial markets overall are often less developed in such places, as are the regulatory infrastructure and supporting professions. Finance sector capacity and capability overall need to be strengthened, therefore, alongside specific capacity building to develop and embed green and sustainable finance principles and practices. Building capacity, capability and culture is not only important in terms of ensuring that financial institutions and the finance sector overall can meet their net zero and other targets and commitments. As we have also seen throughout this book, professional expertise, judgment and scepticism are some of the best defences against greenwashing, which (as we summarize in the next section) is a further major challenge to the continued growth of green and sustainable finance. As the sector grows, and the risks of greenwashing are heightened, greater numbers of Green and Sustainable Finance Professionals, and finance professionals overall with a knowledge of green and sustainable finance principles and practice, are needed to help ensure the continued integrity of green and sustainable finance markets and the mainstreaming of green and sustainable finance across financial services globally.

QUICK QUESTION How would you assess the current capacity, capabilities and culture of your organization in relation to sustainability? What initiatives are under way to build these?

Preventing and avoiding greenwashing Another key theme throughout this book has been the importance of preventing and avoiding greenwashing, both deliberate and inadvertent. This is a major challenge for green and sustainable finance, and for the transition to a sustainable, low-carbon world overall. If consumers, investors and others lack confidence and trust in the claims organizations make regarding their environmental and social sustainability credentials and in the integrity of firms, sectors and markets overall, consumption and investment decisions and behaviours are unlikely to align with the objectives of the Paris Agreement and broader sustainability goals. In Chapter 1, we saw that a majority of institutional investors identified greenwashing as the greatest deterrent to the growth of sustainable investment.

The future of green and sustainable finance

As we have explored elsewhere in this book, there can be many different types of greenwashing, including: ●●

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financial institutions making public commitments to climate change and sustainability that are not backed by consistent action and/or are contradicted by an organization’s activities (for example, launching new ‘ESG’-labelled investment funds whilst still continuing to manage much larger funds containing significant proportions of high-carbon assets); overstating the environmental or social benefits of a product, service or activity (for example, issuing a ‘green bond’ where the proceeds are used to finance gasfired power generation); highlighting the positive environmental or broader sustainability benefits and impacts of a product or service, whilst failing to mention related harms (such as investments in hydro power that have significant impacts on biodiversity and local communities); describing a loan, investment or investment fund as ‘green’ or ‘sustainable’ when in fact only a small part of the financing is used to support sustainable activities; describing an activity, product or service as ‘green’ or ‘sustainable’ without monitoring and verifying outcomes, so the environmental and sustainability benefits are not truly understood (this can often be a problem when relying on ESG ratings, rather than more thoroughly investigating the impacts and outcomes of lending and investment decisions); and emphasizing the environmental benefits and impacts of a product, service or activity without disclosing that these would have been achieved in any case (for example, promoting the issue of an SDG bond when the same projects would have been financed by a regular bond issuance).

As the green and sustainable finance sector and markets grow and develop, and as demographic changes and changing consumer and investor preferences increasingly align with environmental and social sustainability, the incentives for individuals and firms to engage in greenwashing also increase. This is strongly linked with issues of capacity, capability and culture, too; where these are deficient, the risks of inadvertent greenwashing due to a lack of expertise are heightened. The lack of common definitions making it hard to classify economic activities accurately and consistently, and products and services as ‘green’ and/or ‘sustainable’, is also a factor, although the development of taxonomies (if not always completely aligned) helps address this. To support the integrity of green and sustainable finance markets, and to encourage the alignment of finance with the objectives of the Paris Agreement and broader

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sustainability goals, regulators are increasingly developing tools and guidance to detect and prevent greenwashing in the financial services sector, as we discussed in earlier chapters. Many regulators are focused on the retail investment sector, in particular, at present, because of the rapid growth of funds labelled ‘ESG’ and/or ‘sustainable’, and because of the risks of mis-selling. In Chapter  9, we introduced the European Union’s Sustainable Finance Disclosures Regulation (SFDR), for example. There is also strong regulatory encouragement for voluntary market standards, guidelines and frameworks, such as the Green Bond and Green Loan Principles, and other similar sets of principles and guidance as introduced in this book. Greenwashing is not only an issue for the finance sector, however. As we briefly described in Chapter  1, there have been many high-profile cases of greenwashing and broader ‘purpose-washing’, including Volkswagen in Germany in 2015, H&M in Norway in 2019 and Boohoo in the UK in 2020. Such incidents directly impact the finance sector as well, by reducing the value of lending and investment to firms (and, potentially, to whole sectors) accused of greenwashing, and reducing confidence and trust in business overall. As we have reiterated throughout this book, the professional expertise and scepticism of Green and Sustainable Finance Professionals – and finance professionals overall – are among the best defences against greenwashing, and complement the efforts of regulators and other bodies to identify and prevent it.

QUICK QUESTION Have you come across any examples of greenwashing in your personal and/or professional life? What, if anything, did you do about them?

Emerging areas of interest in green and sustainable finance In addition to the progress made to date (and still to be made) in aligning finance with the objectives of the Paris Agreement, wider environmental and other aspects of sustainability are emerging as areas of concern, interest and opportunity for policymakers, regulators and the finance sector. Two areas in particular that Green and Sustainable Finance Professionals should be aware of, and follow developments in, are: a nature-based finance (finance that recognizes our dependency on nature, and seeks to conserve and benefit the environment and nature); and b ocean (‘blue’) finance (although this may be considered as a subset of the former, it is of sufficient importance to be treated separately).

The future of green and sustainable finance

Nature-based finance In Chapter 2, we saw that, according to the UN’s Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services, biodiversity (the full range of ecosystems, species and gene pools – all plant and animal life found on Earth and the habitats in which they live) is declining at a rate unprecedented in human history. Wildlife populations have fallen by 60 per cent since 1970, and some 1 million animal and plant species are threatened with extinction, including more than 40 per cent of amphibians, more than 33 per cent of marine mammals and almost 33 per cent of reef-forming corals.10 We also saw that, according to the WWF, species loss is estimated to be between 1,000 and 10,000 times higher than the natural extinction rate.11 The UNEP’s State of Finance for Nature (2021) report finds that three-quarters of the land and two-thirds of the marine environment have been significantly altered by human actions. Since the beginning of civilization, according to the UNEP and others, 50 per cent of the world’s forests and 70 per cent of the world’s wetlands have been lost.12 The Dasgupta Review (2021) finds that human demands on nature significantly exceed nature’s capacity to supply us with the goods and services we rely on to maintain our current standard of living. Global food production causes the greatest damage to biodiversity. The Review estimates we would require the equivalent of 1.6 planet Earths to maintain standards of living at present levels, and, as nature is harmed or destroyed, our planet’s capacity to support a growing human population at current levels continues to decline.13 While clearly concerning from broad environmental and societal perspectives, such findings are also concerning from a narrower economic perspective, as households, companies and communities are highly dependent on nature and on ‘natural capital’ (the stock of natural assets including air, water, land and all living things). Agriculture, food and beverages and construction are the sectors most dependent on nature, but many more sectors depend on nature directly or indirectly, for example, clothing manufacturers and retailers, and travel and tourism. Just as climate risks are understood as cross-cutting risks with the potential to impact institutional and financial system stability, nature-related risks are also beginning to be understood in similar ways. Yet there are also opportunities for companies, communities and financial institutions that support and finance nature: ●●

The World Economic Forum’s (WEF) ‘New Nature Economy’ Reports (2020) found that some $44 trillion – more than half of the world’s GDP – was moderately or highly dependent on nature, and therefore at risk from losses in biodiversity and other nature-related factors.14 What the WEF terms a ‘new nature economy’ could,

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they estimate, generate up to $10.1 trillion in annual business value and create 395 million jobs by 2030, however.15 ●●

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The Banque de France (2021) estimates that 42 per cent of investments held by French financial institutions come from issuers that are highly or very highly dependent on one or more ‘ecosystem services’ (that is, nature).16 As we saw in Chapter  5, according to De Nederlandsche Bank (2020), Dutch banks, insurance companies and pension funds have around €510 billion (some 36 per cent of total assets) invested in companies reliant on biodiversity around the world.17 The UK’s Dasgupta Review (2021) estimates that the stock of natural capital per person declined by approximately 40 per cent between 1992 and 2014.18 The UNEP’s ‘State of Finance for Nature’ (2021) report estimates that naturebased finance investments would need to at least triple in real terms by 2030, and increase four-fold by 2050 to a total of more than $8 trillion (some $536 billion of annual investment), to meet current global climate change, biodiversity and land degradation targets.19

In addition, nature-based solutions (defined by the International Union for the Conservation of Nature as ‘actions to protect, sustainably manage, and restore natural or modified ecosystems that address societal challenges effectively and adaptively, simultaneously providing human well-being and biodiversity benefits’20) such as restoring forests and wetlands can play key roles in capturing carbon emissions and supporting the global transition to net zero. According to the UNEP, these could provide nearly 40 per cent of the ‘global cost-effective solutions’ required to meet the objectives of the Paris Agreement. They can also help countries and communities enhance their climate resilience by, for example, reducing the risks of coastal or inland flooding. Beyond climate change mitigation and adaptation, nature-based solutions are also seen as being able to address many other societal challenges, such as improving human health and enhancing access to clean and healthy water and food. From both risk and opportunity perspectives, therefore, policymakers, regulators, NGOs and the finance sector are taking an increasing interest in how finance can be aligned with and support nature rather than contributing to environmental harm and destruction through the finance sector’s lending and investment activities. This is, however, a highly complex area; the interdependencies between the many elements of natural systems are not always fully understood from a scientific perspective. The relationship between natural systems and the financial system is also complex and interdependent; finance both impacts nature and is impacted by nature-related physical and transition risks. The economic and financial consequences of this relationship

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are difficult to measure, monitor and report, however. Despite these challenges, though, financial institutions and all organizations can try to: a identify and manage their key dependencies on, and risks arising from nature (for example, are their activities/financing heavily dependent on the availability/quality of water or rising agricultural yields?); and b identify and seek to reduce their impacts on the natural environment, especially biodiversity (such as by avoiding investments that may lead to deforestation, and linking future lending and investment criteria to reforestation and other naturepositive outcomes). To try to align finance with nature, several initiatives have been launched that Green and Sustainable Finance Professionals should be aware of and follow. These include:

The UN Convention on Biological Diversity (CBD) The United Nations Convention on Biological Diversity (CBD) was launched at the UN Conference on Environment and Development (the Rio ‘Earth Summit’) in 1992; it entered into force in 1993, and has been ratified by 196 countries. Two of its three main objectives are (a) the conservation of biological diversity, and (b) ensuring the sustainable use of the components of biological diversity.21 The UN describes the conservation of biodiversity as a ‘common concern of humankind’, noting that the CBD ‘covers all possible domains that are directly or indirectly related to biodiversity and its role in development, ranging from science, politics and education to agriculture, business, culture and much more.’22 Parties to the CBD meet annually in a similar way to the parties to the UNFCCC (introduced in earlier chapters), at the ‘Conference of the Parties’ (COP). Recognizing the impact of finance on the loss of biodiversity, as well as its potential to support nature-based solutions to climate change and other sustainability goals, in 2021 the CBD published the Financial Sector Guide for the Convention on Biological Diversity.23 This sets out why nature is important to the finance sector, and how the sector’s activities can impact nature – both positively and negatively. It also sets out a range of actions financial institutions can take to align their strategies, activities and operations with biodiversity and nature-positive outcomes such as those set out by the Finance for Biodiversity Pledge (see below). It recommends that financial institutions should report in line with the Taskforce on Nature-related Financial Disclosures’ (TNFD) recommendations when these are available (the TNFD was introduced in Chapter 5 and is also covered below).

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READING Aligning financial institutions with biodiversity24 According to the CBD’s Financial Sector Guide for the Convention on Biological Diversity, financial institutions can align their investment strategies, engage with companies and undertake a range of actions to support the conservation and restoration of biodiversity. These include: ●●

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mainstreaming biodiversity into all decision making and strategies, including in biodiversity finance strategies; assessing portfolio and sector impacts and dependencies on nature to understand exposure and setting targets to manage risks identified; engaging with sectors, companies or business models responsible for biodiversity loss to transition them towards nature-positive outcomes, by addressing the drivers of biodiversity loss; increasing opportunities for positive outcomes on the ground, including for nature restoration; requiring disclosure on biodiversity risks, impacts, dependencies and opportunities; and engaging with policymakers on reforming biodiversity incentives and eliminating and redirecting harmful incentives and subsidies for biodiversity, ensuring that they are either positive or neutral for biodiversity.

Financial institutions can also develop their capacities and build their knowledge of biodiversity by: ●●

building internal capacity on the importance of biodiversity and its impacts on investments;

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partnering with data service providers to build reliable and meaningful databases;

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including nature-related data in financial disclosures.

The Finance for Biodiversity Pledge Noting that the finance sector has a key role to play in preventing further biodiversity loss and conserving and restoring nature through its lending and investment activities, 26 financial institutions launched the Finance for Biodiversity Pledge in September

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2020. There are now (2022) nearly 100 signatories to the Pledge. Signatories commit to, by 2024 at the latest: ●●

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collaborating and sharing knowledge on assessment methodologies, biodiversityrelated metrics, targets and financing approaches for positive impact; incorporating criteria for biodiversity in ESG policies, while engaging with companies to reduce their negative and increase positive impacts on biodiversity; assessing financing activities and investments for significant positive and negative impacts on biodiversity and identify drivers of its loss; setting and disclosing targets based on the best available science to increase significant positive and reduce significant negative impacts on biodiversity; and reporting annually on the positive and negative contribution to global biodiversity goals linked to financing activities and investments.25

Guidance to help signatories meet these commitments has been published to help financial institutions understand biodiversity loss and risks, and how to align their strategies, activities and operations with nature-positive outcomes.26 This is a useful source of information for all Green and Sustainable Finance Professionals interested in this area. Like the finance sector alliances and coalitions working together to address the challenges of achieving net zero, many of which were introduced in Chapter 3, the Finance for Biodiversity Pledge provides a forum for the sharing of best practice and a supportive community of professionals and institutions with a common interest in addressing biodiversity loss through collective action.

The Taskforce on Nature-related Financial Disclosures (TNFD) As discussed above, identifying, measuring and reporting organizations’ dependencies and impacts on nature, nature-related risks and recognizing where opportunities may arise from supporting biodiversity and nature, are all challenging due to their complexity. There is also a lack of data, metrics and common methodologies, which makes measuring and comparing dependencies, impacts and risks difficult. Understanding and reporting these, though, is a crucial step in aligning finance with nature-positive outcomes, just as identifying and disclosing climate risks via the Task Force on Climate-related Financial Disclosures (TCFD) supports the alignment of organizations and finance overall with the objectives of the Paris Agreement. Building on the approach of the TCFD, a wide range of financial institutions, plus governments, international organizations and NGOs, established the Taskforce on Nature-related Financial Disclosures (TNFD), launched in June 2021.27 As we noted in Chapter 5, the TNFD aims to develop similar, TCFD-style recommendations for organizations to help them identify, disclose and manage nature-related risks (and identify and take advantage of opportunities). This will steer finance towards outcomes

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that are nature-positive, in alignment with the Paris Agreement, the UN Sustainable Development Goals and the Convention on Biological Diversity. In Chapter  5, we introduced the beta (draft) version of the TNFD’s framework, published in March 2022, and noted that its intention was to publish a final version in late 2023. Green and Sustainable Finance Professionals are advised to follow the work of the TNFD as it develops. In its initial phase, the TNFD has been assessing existing data, metrics and methodologies in order to inform the development of its draft framework and include these in its recommended approaches to disclosure. This has included the work of the CBD and the Finance for Biodiversity Pledge, outlined above, and the Partnership for Biodiversity Accounting Financials (PBAF), introduced next.

The Partnership for Biodiversity Accounting Financials The Partnership for Biodiversity Accounting Financials (PBAF)28 is a sister initiative of the Partnership for Carbon Accounting Financials (PCAF), which we introduced in Chapter 4. Established in 2019 and currently (2022) comprising some 36 financial institutions from nine countries, PBAF’s aim is to develop global standards for assessing and measuring positive and negative biodiversity impacts from financial institutions’ lending and investment activities, similar to the PCAF standard’s objective of assessing and measuring institutions’ financed emissions. In 2022, PBAF published the PBAF Standard v2022, which sets out approaches aligned with those of other initiatives such as the TNFD and the Science-based Targets Initiative that financial institutions can use to analyse their ‘biodiversity footprint’ – the positive and negative impacts of their lending and investment activities on biodiversity.29 The Standard is, at this stage, perhaps best thought of as a guide to good (and emerging) practice for financial institutions, but over time it (or future versions of the Standard) seems likely to be adopted or recommended by bodies such as the TNFD, and perhaps the new International Sustainability Standards Board (ISSB). Ultimately, the joint efforts of initiatives such as PBAF, the TNFD and the ISSB mean that common methodologies for assessing and measuring biodiversity impacts are likely to become recognized, and increasingly become part of financial institutions’ reporting requirements.

QUICK QUESTION Think about the ways in which some of the products and services you regularly use (such as food and clothing) are dependent on nature. How are natural resources impacted – and depleted – as demand for these increases? Are there ways in which their impact on natural resources could be reduced?

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READING Why financial services must take biodiversity seriously30 If we want to achieve net zero by 2050 – and reverse the environmental damage that has already been caused – then we ignore biodiversity at our own peril. In this article, published in Chartered Banker (the Chartered Banker Institute’s journal for its members), we explore the delicate and all-encompassing intricacies of biodiversity and why there is an urgent need for action within the financial sector. Nature and biodiversity – according to 2020 research from the World Economic Forum and PwC – has an economic value generation of $44 trillion. Put bluntly, this means that more than half of the world’s GDP is either moderately or highly dependent on nature, which is battling a number of threats. A recent UN Environment Programme Finance Initiative (UNEP FI) report focuses on nine priority sectors with large financial flows that have significant dependencies or impacts on biodiversity: ●●

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oil and gas storage and transportation31

So, what exactly do we mean by biodiversity in this context – and where does it fit into the wider conversation when there is already growing noise around the transition to a low-carbon future? According to Edward Perry, Biodiversity Analyst in the Environment Directorate at the Organization for Economic Co-operation and Development (OECD): ­ hen we’re talking about biodiversity, we’re talking about the variety of W life on Earth. . . the variety of species on Earth but also the variety within species and of ecosystems. Biodiversity on Earth underpins a range of critical ecosystem services upon which every economic activity depends and upon which human well-being depends. Some of those are specifically relevant for

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climate change. From a climate-mitigation perspective, ecosystems are critical for storing carbon, and, if we look at the adaptation side of things, they also provide a number of other services. Coastal mangroves, for example, provide a buffer from storm surge. Well-planted forests help to reduce erosion, and wetlands not only absorb excess water but also provide a source of water during drier periods. Helen Temple, Chief Executive of The Biodiversity Consultancy, echoes the sentiment and says that biodiversity – or living nature – is foundational to our economy and society: Biodiversity has a fundamental role to play in the wider transition to net zero. Without investment in so-called natural climate solutions – restoring and protecting forests, peatlands and other natural ecosystems – we will never reach the Paris Agreement targets. Biodiversity also has a key role to play in building resilience and enabling us to adapt to a rapidly changing world. Shifting negative finance With a growing understanding around the vital role of biodiversity in the bid to protect the planet, the requirement on the financial sector is multifaceted. Perry says: There are two main angles and we need to see the finance industry focusing on both. The first is drastically reducing the negative impacts that investors and investees are having on ecosystems, which result in significant risks to the financial sector, the economy and broader well-being. Biodiversity loss is widespread and accelerating. We’re seeing one million plant and animal species now threatened with extinction. Around 10 million hectares of forest a year are being cut down. As we degrade those ecosystems, it undermines their capacity to sequester carbon, and their resilience to climate change. From a finance perspective, it’s a question of shifting negative finance and making that finance nature-positive or at least neutral. The second part, Perry believes, is about exploring the commercial opportunities of restoration: T­ here is a lot of degraded land out there, and through careful intervention we can restore ecosystems to restore the capacity they have to provide critical services such as pollination, provision of raw materials, climate regulation and protection from climate-related hazards. There are a lot of opportunities that can come from investing in more nature-positive businesses.

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Nature positive For Temple, too, the finance sector has an ‘incredibly powerful’ role to play in ensuring that financial flows are directed away from activities that are harmful to the planet and towards activities that are beneficial: In practice, this means understanding biodiversity risk exposure across an organization’s portfolio and putting in place stronger due diligence processes, including ‘no-go’ for investment in activities that are particularly damaging. It’s also about exploring opportunities to invest in companies or assets that are nature-positive. Active ownership is key. Right now, we need to get the basics right – strengthening due diligence and using the leverage that the financial system has to put pressure on companies and assets to clean up their acts. In the medium term, we need to make sure companies and banks are reporting on biodiversity and nature risk in a transparent and standardised way – the recently formed Taskforce on Nature-related Financial Disclosures (TNFD) is working towards this, and legislation in the EU and other jurisdictions is moving in this direction, too. She continues: In terms of positive investments – a key priority is making sure that the money flowing into carbon offsets have measurable positive benefits for biodiversity as well. At the moment, we are seeing a lot of poorly thought-out tree-planting projects that aren’t sustainable in the long term and that are actively harmful to natural ecosystems and species. Two sides of the same coin The global approach to mitigate climate change is at a critical juncture, with a huge variation in strategy and policy across both region and sector. But it’s collaboration that experts across the board agree is essential for putting real and significant change into practice. Perry comments: The OECD works closely with governments and the financial sector. The OECD Green Finance and Investment Forum, for example, organizes an annual event bringing together governments, investors, businesses and other stakeholders. Over the past years, one of our aims has been to bring biodiversity into that conversation on climate change, recognizing that these two issues are two sides of the same coin. We can’t achieve the goals of the Paris Agreement without tackling the equally big and related challenge of biodiversity loss. And,

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reciprocally, we cannot fully address biodiversity loss without addressing climate change – one of the five key drivers of biodiversity loss. In 2021, the OECD published a report for the G7, Biodiversity, Natural Capital and the Economy: A policy guide for finance, economic and environment ministers, which explored the question of integrating biodiversity into the financial sector. But it seems that the question of biodiversity is still not being given the consideration it deserves. Perry continues: I think it’s fair to say that the financial sector still has further to go to integrate climate change to the extent it needs to be integrated, and to shift finance flows to align with the Paris Agreement goals. Biodiversity is lagging even further behind. I do think, however, there is growing recognition within the financial sector that this is an issue – both biodiversity loss in its own right and its links to climate change. For example, the Central Bank of the Netherlands recently published a report on biodiversity, conservatively estimating that around 36 per cent of Dutch financial institutions’ investments are highly dependent on nature. Things are definitely moving. Barriers to change So, what are the biggest barriers to changing our collective approach to protecting the Earth’s invaluable ecosystems? For Temple, it certainly isn’t a lack of available information on biodiversity: People sometimes talk about this being a barrier, but this isn’t true. We have a wealth of information about biodiversity available on easily accessible platforms that enables financial institutions to start taking effective action on biodiversity now. One barrier to change, however, is the inherent inertia in large and complex systems. It took a long time for the financial sector to really start taking climate change seriously, and we can’t wait that long again for effective action on nature and biodiversity. A more fundamental barrier is that we need to accept that incremental change isn’t going to solve the climate and nature crisis. We need transformational change in moving towards a truly circular, low-carbon economy that values and conserves nature. At the moment we’re rearranging the deckchairs on the Titanic – we need to be brave enough to embrace some fundamental changes to how we do business.

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Ocean finance As we noted in the introduction to this section, ocean finance (sometimes referred to as ‘blue finance’) may be considered as a subset of nature-based finance. Marine ecosystems are a very important part of nature overall, with oceans containing some 97 per cent of all water and an estimated 80 per cent of all life forms. According to the UNEP, the annual economic value of the oceans is estimated at $2.5 trillion annually, equivalent to the world’s seventh-largest economy.32 The OECD forecasts that economic activities supported by our oceans (referred to as the ‘blue economy’) will rise to $3 trillion annually by 2030.33 Major economic sectors, including aquaculture, fishing, shipping and tourism, depend on the ocean – and on the health of the ocean ecosystem – as do many coastal communities, especially in the developing world. It is estimated that approximately half a billion people rely on fish from coral reefs as their main source of protein. In addition, offshore wind and other forms of renewable energy (for example, tidal and wave power) also depend on the oceans. As we noted previously, however, ocean ecosystems have been heavily depleted, with a third of marine mammals becoming extinct, and a similar proportion of coral reefs dying. In Chapter 2, we saw that oceans and marine ecosystems were expected to reach critical thresholds at 1.5°C and above. Warming oceans contain less oxygen, and are also more acidic, as increasing concentrations of CO2 are dissolved in the water. These, and other factors, lead to extinction, loss of breeding grounds and mass movements of species that disrupt ecosystems in other parts of the oceans. Coral reefs, for example, are projected to decline by a further 70–90 per cent in a 1.5°C scenario. With global warming of 2°C, virtually all coral reefs would be lost. This would not only be devastating for the ocean; it would also have major impacts on human society and economic life as valuable sources of food and economic activity were severely damaged or destroyed. At present, according to the United Nations Environment Programme Finance Initiative (UNEP FI), the finance flows to support sustainable marine ecosystems and a sustainable ‘blue economy’ are limited. Existing finance tends to support economic activities and sectors that detract from rather than support marine ecosystems. As with the wide range of nature-related risks discussed above, finance impacts the oceans, and physical and transition risks impact on the finance sector itself.34 Working with the European Commission, the WWF, the World Resources Institute (WRI) and the European Investment Bank (EIB), UNEP FI has published the Sustainable Blue Economy Finance Principles as part of the wider Sustainable Blue Economy Finance Initiative.35 This aims to align finance with sustainable ‘blue finance’ practices, as set out in the Principles.

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READING Sustainable Blue Economy Finance Principles36 We work across the financial community to provide guidance and frameworks to ensure investment, underwriting and lending activities are aligned with the UN Sustainable Development Goal 14 (SDG 14), ‘life below water’, enabling financial institutions to rebuild ocean prosperity, restore biodiversity and regenerate ocean health. We commit to applying the following principles across our portfolios, regardless of whether we are majority or minority investors: 1 Protective: We will support investments, activities and projects that take all possible measures to restore, protect or maintain the diversity, productivity, resilience, core functions, value and the overall health of marine ecosystems, as well as the livelihoods and communities dependent upon them. 2 Compliant: We will support investments, activities and projects that are compliant with international, regional, national legal and other relevant frameworks which underpin sustainable development and ocean health. 3 Risk-aware: We will endeavour to base our investment decisions on holistic and long-term assessments that account for economic, social and environmental values, quantified risks and systemic impacts, and will adapt our decisionmaking processes and activities to reflect new knowledge of the potential risks, cumulative impacts and opportunities associated with our business activities. 4 Systemic: We will endeavour to identify the systemic and cumulative impacts of our investments, activities and projects across value chains. 5 Inclusive: We will support investments, activities and projects that include, support and enhance local livelihoods, and engage effectively with relevant stakeholders, identifying, responding to, and mitigating any issues arising from affected parties. 6 Cooperative: We will cooperate with other financial institutions and relevant stakeholders to promote and implement these principles through sharing of knowledge about the ocean, best practices for a sustainable Blue Economy, lessons learned, perspectives, and ideas. 7 Transparent: We will make information available on our investments and their social, environmental and economic impacts (positive and negative), with due respect to confidentiality. We will endeavour to report on progress in terms of the implementation of these Principles.

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8 ­Purposeful: We will endeavour to direct investment to projects and activities that contribute directly to the achievement of Sustainable Development Goal 14 (‘Conserve and sustainably use the oceans, seas and marine resources for sustainable development’) and other Sustainable Development Goals, especially those which contribute to good governance of the ocean. 9 Impactful: We will support investments, projects and activities that go beyond the avoidance of harm to provide social, environmental and economic benefits from our ocean for both current and future generations. 10 Precautionary: We will support investments, activities and projects in our ocean that have assessed the environmental and social risks and impacts of their activities based on sound scientific evidence. The precautionary principle will prevail, especially when scientific data is not available. 11 Diversified: Recognizing the importance of small to medium enterprises in the Blue Economy, we will endeavour to diversify our investment instruments to reach a wider range of sustainable development projects; for example, in traditional and non-traditional maritime sectors, and in small- and large-scale projects. 12 Solution-driven: We will endeavour to direct investments to innovative commercial solutions to maritime issues (both land- and ocean-based) that have a positive impact on marine ecosystems and ocean-dependent livelihoods. We will work to identify and to foster the business case for such projects, and to encourage the spread of best practice thus developed. 13 Partnering: We will partner with public, private and non-government sector entities to accelerate progress towards a sustainable Blue Economy, including in the establishment and implementation of coastal and maritime spatial planning approaches. 14 Science-led: We will actively seek to develop knowledge and data on the potential risks and impacts associated with our investments, as well as to encourage sustainable investment opportunities in the Blue Economy. More broadly, we will endeavour to share scientific information and data on the marine environment. As of June 2022, more than 70 banks, insurers and investors have joined the Sustainable Blue Economy Finance Initiative.

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As the UNEP FI notes, banks, insurers and investors have major roles to play in financing a sustainable blue economy, helping to rebuild ocean prosperity and restoring biodiversity to the oceans. Through their lending, underwriting and investment activities, as well as their client relationships, financial institutions have a major impact on ocean health, and can accelerate and mainstream the sustainable transformation of ocean-linked industries. First, though, they must cut down on or cease financing activities, firms and sectors that harm oceans and marine ecosystems. Tools and techniques developed to support firms’ transitions to net zero emissions, such as sustainability-linked loans and bonds, can be adapted and deployed to help firms and sectors invest in cleaner technologies and business models that support sustainability in the oceans (‘blue bonds’ were introduced in Chapter 7). Specialized investment funds, such as the Ocean Engagement Fund, which invests in firms that ‘proactively address ocean health’, adopt a specialized, thematic approach to impact investment.37 Other investment managers specialize in other aspects of ocean finance, such as Marine Capital,38 which acquires and operates sustainable shipping on behalf of institutional investors. Development banks can play a particularly important role in growing ocean finance, as they are often able to take greater risks, have longer-term time horizons than the private sector, and have more experience working in the developing world – where ocean finance can be key. The Asian Development Bank, for example, has published an ‘Ocean Finance Framework’ that sets out priorities and criteria for finance aligned with its Action Plan for Healthy Oceans and Sustainable Blue Economies. This in turn aims to protect and restore coastal and marine ecosystems, grow sustainable blue economies, build resilient coastal communities and contribute to food security in Asia and the Pacific.39 As with nature-based finance in general, ocean finance is a rapidly evolving area. Green and Sustainable Finance Professionals are advised, therefore, to keep up with developments, particularly via the Sustainable Blue Economy Finance Initiative introduced above.

QUICK QUESTION To what extent does the institution you work for, or one you are familiar with, consider nature-based finance (including ocean finance) in its sustainability strategy, activities and operations?

The future of green and sustainable finance

Your role and future as a green and sustainable finance professional ‘Never doubt that a small group of thoughtful, committed citizens can change the world; indeed, it’s the only thing that ever has.’ Margaret Mead, anthropologist In the course of this book, we have seen how vital it is to align finance with the objectives of the Paris Agreement, the UN Sustainable Development Goals and wider sustainability objectives to achieve a successful transition to a more sustainable, low-carbon world. We have considered some of the successes and challenges in mainstreaming green and sustainable finance. We have introduced and examined a wide range of international, national and finance sector initiatives that aim to align finance and sustainability. Whilst international and national initiatives, and institutions large and small, have key roles to play, so too do individuals. Finance is built on pillars of financial and human capital. Change is led, ultimately, by individuals persuading others, making decisions and acting in a way that leads to organizational, sectoral and societal transformations. An organization itself does not instigate change; individuals within that organization do. The change we seek in mainstreaming green and sustainable finance therefore needs to be led by large and increasing numbers of finance professionals with an understanding of the critical role of finance in supporting the transition to a sustainable, low-carbon world, so that a strong and purposeful culture that aligns finance and sustainability is developed and sustained. To do this, finance professionals need to combine their knowledge and skills of finance with an understanding of the principles and practice of green and sustainable finance. This will enable professionals to develop and deploy products, services and tools that can mobilize capital to support the transition, address climate and other sustainability risks, and incentivize sustainable business models and production among firms and consumption choices among households. Finance professionals at all levels, and in all types of roles, functions and organizations, can choose to apply green and sustainable finance principles and practice in their work, and can encourage colleagues to do likewise. The opportunity for Green and Sustainable Finance Professionals to play more strategic, higher-profile roles has never been greater. Until recently – certainly prior to the Paris Agreement, and in the years immediately following its signing in 2015 – green and sustainable finance tended to be seen as a specialist niche, with Green and Sustainable Finance Professionals in relatively junior roles, struggling to secure senior management time and sponsorship for the

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integration of climate, environmental and broader sustainability risks and opportunities into decision making. This is now changing, prompted by developments in policy and regulation, the growth of the green and sustainable finance market, and by changing demographics and evolving customer, investor and general societal preferences and behaviours. Since the Covid-19 pandemic, in particular, there has been a noticeable shift in chair, CEO and board-level engagement with sustainability in many financial institutions – and in economic and public life more generally. Many senior financial services executives and regulators have adopted a higher public profile on sustainability issues, and there is significant growth in the number of senior sustainability, climate risk and ESG roles within many firms. Boards and senior executives of financial institutions, prompted by initiatives such as the UN Principles for Responsible Investment, the Principles for Responsible Banking and the Principles for Sustainable Insurance, are increasingly aligning their firms’ strategies, capital allocation decisions, activities and operations with the objectives of the Paris Agreement and the UN Sustainable Development Goals. Many firms are making binding commitments to net zero and challenging interim targets via groupings such as the Glasgow Financial Alliance for Net Zero (GFANZ) and its constituent Net Zero Alliances. The opportunities for Green and Sustainable Finance Professionals – in career terms, but also in terms of making an impact within their organization and on the finance sector and society as a whole – have never been greater. To support the continued growth of the sector, though, the numbers of Green and Sustainable Finance Professionals, and finance professionals in general having at least a working knowledge of green and sustainable finance principles and practice, need to be significantly increased.

Green and sustainable finance knowledge and skills Developing the green and sustainable finance knowledge and skills of finance professionals will help support the alignment of finance with the objectives of the Paris Agreement and the UN Sustainable Development Goals. This is the motivation behind the Chartered Banker Institute’s Green and Sustainable Finance CertificateTM, the world’s first benchmark qualification for green and sustainable finance, which this book was originally written to support.40 Proposed by the UK’s Green Finance Taskforce in 2017, the Certificate was launched in 2018, and sets the global benchmark standard for the knowledge and skills required by individuals working in green and sustainable finance. As we have seen throughout this book and course, building the capacity and capability of the finance sector so that ‘every professional financial decision takes climate change into account’ (as well as broader sustainability factors) requires every finance professional to develop at least a basic knowledge of

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the principles and practice of green and sustainable finance relevant to their role, function and organization. Recognizing the need for collective action to build the capacity and capabilities of the finance profession in this area, 12 leading chartered and professional bodies launched the Green Finance Education Charter in 2020.41 The Charter commits signatories to developing a qualification and CPD programmes for professionals that incorporate green and sustainable finance principles and practice, so that over time all finance professionals will develop at least a basic knowledge and understanding of these alongside their professional specialisms. Charter signatories represent a wide range of professionals, and a substantial number of individuals who are fundamental to aligning finance with the objectives of the Paris Agreement and the UN Sustainable Development Goals.

­R EADING Green Finance Education Charter – building the capacity and capability of the finance sector42 Simon Thompson, Chief Executive of the Chartered Banker Institute, discusses the skills finance professionals need to support the transition to net zero. In the approach to COP26, a key topic of discussion at London Climate Action Week is how the power of the City of London can be harnessed to make rapid progress on the Road to Glasgow. Successfully limiting global warming to below 2°C above preindustrial levels requires a systemic global transition – the Race to Net Zero. Every economic activity, and every economic actor and entity, will be impacted. The scale, scope and pace of change required is unprecedented. Financing this transition requires the rapid decarbonization and redeployment of global capital in support of net zero, and a realignment of the finance sector so that, in Mark Carney’s words, ‘every professional financial decision take climate change into account.’ Ambitious, collective action is required, such as the Glasgow Financial Alliance for Net Zero (GFANZ), which brings together financial institutions that commit to using science-based guidelines to reach net zero by 2050 at the latest, and set challenging interim targets for 2030. Achieving these targets requires equally ambitious, collective action to upskill and reskill finance professionals to ensure the finance sector has the capacity and capabilities required. We will not meet our interim or mid-century commitments by doubling, quadrupling or even increasing ten-fold the number of specialist sustainability professionals working in finance. To pass the ‘Carney Test’, every finance professional needs to develop and apply a knowledge and understanding of

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climate change, green finance and sustainability to the extent appropriate for their role, function and the organization they work for. Recognizing the capacity and capability constraints to the finance sector’s collective ambition, and in support of the UK’s climate action leadership in the pathway to COP26, the Green Finance Education Charter was developed. The Charter is a world first, designed to help build the capacity and capability of the UK’s finance sector to meet its net zero commitments. It brings together 12 leading professional bodies representing more than 1 million accountants, actuaries, bankers, financial analysts, insurers, investment managers, treasurers, risk managers and other professionals who are key to the mobilization of sustainable finance in the UK and globally. By incorporating the principles and practice of green and sustainable finance into our education programmes for finance professionals worldwide, we can help ensure that ‘every professional financial decision takes climate change into account’, and broader sustainability factors too. In its first year, the Green Finance Education Charter signatories, supported by the Green Finance Institute, have developed a wide range of green and sustainable finance education resources for members and students, including new, global benchmark qualifications such as the Certificate in Green & Sustainable Finance (Chartered Banker Institute), Certificate in Climate Risk (Chartered Body Alliance) and Certificate in ESG Investing (CFA Society of the UK). Charter signatories have also launched an open source, Green Finance Education Toolkit, to provide resources for those seeking to develop capacity and capability overseas. But we need to do more if GFANZ members, and the finance sector overall, are to meet their public net zero commitments. In particular, green and sustainable finance education and skills must be taken up worldwide. Only a significant global commitment, supported by sector-wide investment in education and skills, will allow us to build the global capacity and capability needed. The next step, therefore, is to develop a more ambitious, international version of the Green Finance Education Charter. This will set out our vision for a global gold standard for climate- and sustainability-aligned professional education and training, supported by commitments from educators, regulators, policymakers and financial institutions, to ensure the global upskilling and reskilling of finance professionals at the scale and speed needed to meet the 2030 targets. For every professional financial decision to take climate change into account, every finance professional needs to develop and apply a knowledge and understanding of climate change and sustainability. The ambition is set. We now need collective action to match, based on the GFANZ model – a Global Alliance for Finance Skills for Net Zero.

The future of green and sustainable finance

Green and sustainable finance values What many consider as ‘green and sustainable values’ (such as stewardship of people and planet, a sense of social purpose and a focus on the longer term) are consistent with what many also perceive as the values on which a successful and sustainable finance sector, and finance profession overall, are built. Many initiatives in recent years, particularly in response to the Global Financial Crisis, have set out the values expected of financial services professionals in Codes of Ethics, Codes of Conduct and the like at the national, industry and firm levels. These include the Chartered Banker Code, to which all members of the Chartered Banker Institute subscribe. There are many similarities between such codes, which commonly include values including or similar to the following:

Stewardship Stewardship is commonly defined as the careful and responsible management of resources. Traditionally, in a financial services context, stewardship was narrowly defined in terms of the careful and responsible (‘professional’) management of depositors’ and investors’ funds. In many philosophical and religious contexts, however, a much wider concept of stewardship is considered – the careful and responsible management of natural resources. In the context of green and sustainable finance, this wider approach to stewardship of natural resources, people and planet is an extension of the traditional approach.

Integrity Integrity refers to consistently demonstrating high moral standards. A finance professional who displays integrity will steadfastly adhere to their moral values despite pressure exerted to do otherwise. Integrity is an important quality because laws, rules and codes cannot define every situation or dilemma an individual might face. We have often referred in this book to the need to ensure market integrity, often in terms of principles, guidance and other initiatives designed to avoid greenwashing (such as the Green Bond and Green Loan Principles). Regulation, market standards and guidance will not cover every situation finance professionals will encounter in a green and sustainable finance context, especially because of the rapid growth and development of the sector. The professional integrity of individuals is key, therefore, in ensuring that actions and decisions taken are genuinely aligned with sustainable objectives and outcomes, and that greenwashing is avoided.

Fairness Fairness refers to making decisions in a just, even-handed way, without discrimination, favouritism or preference based on personal value judgements. Fairness within

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financial services traditionally implies that policies and practices should be applied objectively, without undue influence (for example, loan applications should not be favoured or rejected depending on who the applicant is or their relationship with the individual making the decision). It can be argued that ignoring the environmental and broader sustainable aspects of financial activities is incompatible with fairness, since those aspects may affect certain groups disproportionately, such as those living in poverty or in areas that are highly vulnerable to climate change. As we saw in earlier chapters, these groups and individuals are often not considered or included in decision making in the finance sector, despite being impacted by the externalities the sector generates. There is also an important intergenerational aspect to fairness; sustainability refers to future generations as well as the current generation, and the outcomes of lending, investment and underwriting decisions taken today will have positive or negative effects on future generations. Green and Sustainable Finance Professionals should consider these wider contexts of fairness, therefore, when making decisions and choosing between alternative courses of action.

Openness and transparency Openness and transparency refer to the preparedness to reveal or make available relevant or appropriate information, and also not to conceal relevant information even though it might not support a chosen course of action or could cause embarrassment. In business, it is essential that a firm’s financial accounts provide a true and fair view of its financial situation, presenting the facts as they are, and not omitting important information that investors and other users of the accounts require. Complete transparency in business and finance is not an absolute duty, however, as commercial decisions sometimes involve a need for secrecy, such as when a new product or service is to be launched. Individuals also have the expectation (and right) for personal data not to be disclosed without permission. The extent to which organizations should be open about their environmental and social impacts is an increasingly important aspect of transparency. As we have seen during this book and course, disclosure of these is developing rapidly, led by initiatives such as the TCFD and, more recently, the TNFD. In addition, NGOs research and publish information on the involvement of companies (including financial institutions) in environmentally and socially harmful activities, especially where they believe the organizations involved are greenwashing by attempting to minimize or hide their harmful impacts. Being open and transparent about the negative impacts of decisions and activities – both intended and unintended – is part of acting with integrity, which, as we saw above, is a key value expected of Green and Sustainable Finance Professionals.

The future of green and sustainable finance

Responsibility Responsibility is a duty, obligation or burden. In a professional context, it relates to what an individual is required by their employer to do as part of their job, but there is a wider aspect to this, too, as there will also usually be requirements imposed by the law, regulation, professional bodies and similar. These will normally be codified and written down. Many argue that individuals – especially professionals – also have broader responsibilities to society, which will not necessarily be codified in this manner. We might, for example, accept that as individuals we have a responsibility to respect the natural environment in our personal and professional lives, either because a healthy environment is vital for society to function, or because the environment is seen as a source of positive benefit in itself and worthy of protection. We might also consider that we have a responsibility to a wider group of stakeholders than those immediately impacted by financial decisions, including to current and future generations, as advocates for sustainability would maintain. The Chartered Banker Institute argues that all finance professionals should demonstrate a personal commitment to stewardship in the broadest sense – sustaining customers’, communities’ and society’s resources – not just financial resources, for long-term economic benefit and for the benefit of future generations. Green and Sustainable Finance Professionals, indeed all finance professionals, have a responsibility – a duty – to act in these wider interests, not just in their own or their employer’s narrow interests.

Accountability Accountability is taking ultimate responsibility for a duty or an obligation. As the Global Financial Crisis in 2008 demonstrated, in many cases it has been hard for regulators to hold senior financial services professionals to account for the failure of financial institutions, and the individuals concerned may not have felt accountable themselves, but felt they were part of a system that failed. This perceived lack of accountability caused many in the wider world beyond financial services to feel that the system was ‘unfair’, leading to substantial declines in confidence and trust in banking and finance. Linked to responsibility, Green and Sustainable Finance Professionals (and, the Chartered Banker Institute argues, all finance professionals) have a duty to consider environmental and social sustainability factors in their actions and decisions. Individuals should hold themselves accountable for the consequences of their actions and decisions. This includes being open and transparent about, and accepting responsibility for, negative impacts and environmental and social harms caused by lending, investment and underwriting decisions, whether these could be foreseen or were unintentional. Over time, this approach builds confidence and trust in the integrity of individual finance professionals, and in the finance sector and profession overall,

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supporting the continued growth and development of green and sustainable finance and the continued alignment of finance with the objectives of the Paris Agreement and the UN Sustainable Development Goals. To help Green and Sustainable Finance Professionals, and finance professionals more generally, apply these and similar values in the context of their role, function and organization – their daily professional practice – the Chartered Banker Institute has developed guidance on the Chartered Banker Code, to which all members of the Institute subscribe, relating to the application of the seven principles of the Code in a green and sustainable finance context:

CASE STUDY The Chartered Banker Code for Green and Sustainable Finance Professionals43 All individuals working in financial services should act in a fair and honest manner. This is to help protect the interests of customers, colleagues and counterparties and the wider interests of society. As a minimum, compliance with legislation, regulation and industry/employer codes and standards is required. The Chartered Banker Institute, the oldest institute of bankers in the world, founded in 1875, believes that to enhance public confidence and trust in banks and bankers, and pride within the banking profession, individuals working in banking should make a personal commitment to a higher standard of professionalism, such as that set out in the Institute’s Chartered Banker Code. The Chartered Banker Code sets out the ethical and professional values, attitudes and behaviour the Institute expects of all professional bankers. Membership of the Chartered Banker Institute brings with it additional responsibilities. All members are expected to act as role models to others working in the banking industry, leading by example and displaying high standards of professionalism and a commitment to ethical conduct and the public interest at all times. Members are also expected to conduct their affairs in a manner that upholds the name and reputation of the Chartered Banker Institute, and the banking profession more broadly. The Institute has developed a version of the Chartered Banker Code for Green and Sustainable Finance Professionals, reproduced below. The seven principles on which the Code is based are exactly the same as those on which the Chartered Banker Code itself is based, with additional guidance provided as to how these principles may apply in the context of green and sustainable finance. It sets out how members may incorporate green and sustainable finance principles and values into their professional practice.

The future of green and sustainable finance

I will demonstrate my personal commitment to professionalism in banking, and to the principles and practice of green and sustainable finance, by: 1 Treating all customers, colleagues and counterparties with respect and acting with integrity Acting with integrity requires Green and Sustainable Finance Professionals to take active steps to ensure that their activities and, as far as possible, those of their organizations, are aligned with and support the transition to a lowcarbon, sustainable world. It involves ensuring that advice given to customers, colleagues and counterparties is consistent with promoting this transition, and that financial activities that may damage the environment and society are identified and disclosed. Green and Sustainable Finance Professionals have a particular responsibility to avoid ‘greenwashing’, and should take active steps to ensure their advice and activities do not in any way damage the integrity of the finance profession. 2 Developing and maintaining my professional knowledge and acting with due skill, care and diligence; considering the risks and implications of my actions and advice, and holding myself accountable for them and their impact Green and Sustainable Finance Professionals should take active steps to regularly update their knowledge of the principles and practice of green and sustainable finance, and of emerging best practice, recognizing that this is a sector developing very rapidly. Considering the risks and implications of actions and advice requires detailed consideration of the climate, environmental and social sustainability risks involved, and how these may be appropriately identified, disclosed and managed. Green and Sustainable Finance Professionals should hold themselves accountable for the impact of their activities and advice on the environment and on communities impacted by climate change and other environmental and social sustainability factors; they should seek where possible to use their knowledge and skills to support activities that will have positive impacts on the environment and society; and they should avoid activities that may damage the environment and society. 3 Being open and cooperative with regulators; complying with all current regulatory and legal requirements Complying with the current and emerging regulatory requirements relating to green and sustainable finance is expected of all finance professionals. Green and Sustainable Finance Professionals should take additional steps to comply with relevant market frameworks and standards, even when these are voluntary. Green and Sustainable Finance Professionals should also, where possible, work

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with regulators and other stakeholders to shape and develop legal and regulatory requirements to ensure a consistent approach to identifying, disclosing and managing climate, environmental and other sustainability risks, and to promote market integrity in the area of green and sustainable finance. 4 Paying due regard to the interests of customers and treating them fairly Green and Sustainable Finance Professionals should also pay due regard to the interests of future generations of customers, balancing the needs of customers today and tomorrow for sustainable financial returns, and for an environment and society able to support these. They should treat future generations fairly by acting prudently and professionally as stewards of natural and financial resources for the long term, rather than being motivated by maximizing short-term returns. Treating customers fairly also requires Green and Sustainable Finance Professionals to present the full details and potential impacts of recommended or suggested products and services to customers, including both positive and negative impacts on the environment and society. 5 Observing and demonstrating proper standards of market conduct at all times This requires Green and Sustainable Finance Professionals to develop their knowledge of, and act in accordance with, voluntary frameworks and market standards of green and sustainable finance practice that go beyond the legal and regulatory requirements. Where possible, Green and Sustainable Finance Professionals should take active steps to help develop, implement and embed frameworks and standards within their own organizations and sectors. 6 Acting in an honest and trustworthy manner, being alert to and managing potential conflicts of interest Green and Sustainable Finance Professionals should be honest with themselves, with customers and with colleagues about the impacts of financial activities that may damage the environment and society. Being trustworthy requires that Green and Sustainable Finance Professionals must actively avoid being involved in ‘greenwashing’, and must not overstate the environmental and societal benefits, or avoid disclosing environmental and societal harms, of financial activities. Conflicts of interest can arise when Green and Sustainable Finance Professionals have to balance the needs of customers, shareholders and others for shortterm financial returns with longer-term, sustainable financial and environmental returns. Green and Sustainable Finance Professionals should be aware of this conflict, and should seek to encourage a sustainable approach wherever possible; when this is not possible, this should be clearly documented and disclosed.

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7 Treating information with appropriate confidentiality and sensitivity In financial services, maintaining the confidentiality of customer and commercial data and information, subject to legal and regulatory disclosure requirements, is of great importance. This applies equally to Green and Sustainable Finance Professionals. There may be occasions, however, when, to maintain the integrity of the green and sustainable finance profession and avoid ‘greenwashing’, Green and Sustainable Finance Professionals should disclose information, with appropriate safeguards, where this would be in the public interest. Green and Sustainable Finance Professionals should first seek to work within organizational and industry channels for ‘speaking up’ before publicly disclosing such information.

Finance is a rapidly changing and developing sector and profession where major change and disruption can and often do occur. The impact of the Global Financial Crisis in 2008 and the emergence of digital finance and FinTech over the past decade are two examples of this that continue to have very significant and long-lasting impacts on the practice of banking, investment and insurance. A major change to align finance with the objectives of the Paris Agreement and the UN Sustainable Development Goals, and to mainstream green and sustainable finance more generally, is underway, led and supported by the economic, scientific and societal factors discussed throughout this book. As we have seen, an increasing understanding of the risks and opportunities presented by climate change and other environmental and social sustainability factors, supported by developments in policy and regulation and evolving customer, investor, employee and societal preferences and behaviours, have led many financial services firms to incorporate sustainability in their strategies, activities and operations. Ultimately, however, it is individual finance professionals who will ensure the continued growth and development of green and sustainable finance. By implementing green and sustainable finance principles and practice, such as those outlined in this book, in their work as bankers, investors and insurers, and encouraging others to do likewise in sufficient numbers, the changes required to ensure that ‘every professional financial decision takes climate into account’ (and broader aspects of sustainability, too) and that finance becomes fully aligned with the transition to a sustainable, lowcarbon world, are within reach.

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Personal reflection Take some time to reflect on the challenges and opportunities that have been highlighted throughout this book and what they might mean to you as an individual. First, think about your own strengths and weaknesses, and then think about your role in your organization and other organizations/networks you may be part of, as well as how you can use these to make a positive difference. In the space below, write down what you think are your main strengths. For example, think about whether you have any applicable subject, product or sector-specific knowledge; if you are good at research; at networking and collaboration; at liaising with senior executives, policymakers or organizations; at finding or creating investment opportunities, or perhaps at assessing and managing risk. My strengths:

Reflect on the main challenges to developing and implementing deep green and sustainable strategies, principles and practice in your role, organization and the finance profession. Challenges for your role:

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Challenges for your immediate colleagues/team/department:

Challenges for your organization:

Challenges for your sector:

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Next, building on these reflections, imagine yourself in the role of a changemaker, contributing to the transition to a low-carbon world. Summarize the opportunities you can take advantage of below. Opportunities for you as an individual consumer and investor/saver:

Opportunities for you in your professional life:

Opportunities for your organization:

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Opportunities for your sector:

Now, think about how you would like to continue to build and use your knowledge of green and sustainable finance to develop your career and write your answers below. Which areas of green and sustainable finance have I most enjoyed learning about?

Which are most useful in my current/future career?

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Which areas would I like to develop my knowledge and skill further in, and how could I go about doing that?

Where do I see myself in 12 months’, 5 years’ and 10 years’ time? How will my role and career have evolved? How would I like my career to develop?

Think about how you would like to continue to build and use your knowledge of green and sustainable finance to develop your career:

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Which areas of green and sustainable finance have I most enjoyed learning about?

Which are most useful in my current/future career?

­ inally, to conclude this section, note down some action points and associated deadF lines to help you start working towards achieving these aims. For example: research your organization’s green and sustainable strategies, activities, operations, products and services; prepare a presentation for colleagues to introduce the key concepts of green and sustainable finance; develop an action plan to increase customer awareness of green and sustainable finance; or develop a career plan for your future. Action points:

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Key concepts In this chapter, we considered: ●●

●● ●●

●●

●●

progress to date in aligning finance with the objectives of the Paris Agreement and the UN Sustainable Development Goals; key challenges to the further growth of green and sustainable finance; emerging areas of interest in green and sustainable finance – especially naturebased and ocean finance; the role of Green and Sustainable Finance Professionals, and what individuals can do to promote and embed green and sustainable finance principles and practice; and how you can develop a personal action plan for embedding the principles and practice of green and sustainable finance in your professional activities

Now go back through this chapter and make sure you fully understand each point.

Review In this final chapter, we revised some of the key themes covered in this book, considered the extent to which the finance sector has aligned its strategies, activities and operations with the objectives of the Paris Agreement and other sustainability goals, and examined some of the barriers and challenges to embedding green and sustainable finance principles and practice across the finance sector. We introduced some key, emerging areas of interest that Green and Sustainable Finance Professionals should be aware of and follow developments in, and considered the role(s) individuals play in embedding green and sustainable finance principles and practices in their organization, and in finance more broadly. There has been considerable progress in aligning finance with the objectives of the Paris Agreement, the UN Sustainability Goals and other sustainable objectives. Evidence of this comes from: ●●

●●

­ olicy and regulatory responses to climate change, and broader environmental and p social sustainability challenges at the global, regional, national and finance sector levels. Central banks and financial regulators, in particular, are leading efforts to identify, disclose and manage climate risks (and, in some cases, broader sustainability risks), and to support the growth of green and sustainable finance; market developments and growth, such as the growth of the green and sustainable bond and sustainable investment markets in recent years; and

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the growth in size and impact of key finance sector initiatives, such as the Principles for Responsible Investment (PRI), Principles for Responsible Banking (PRB), Principles for Sustainable Insurance (PSI) and the Glasgow Financial Alliance for Net Zero (GFANZ).

Aligning finance with sustainability, and mainstreaming green and sustainable finance, ultimately requires green and sustainable finance principles and practices to be irreversibly adopted, implemented and embedded across the whole global financial system. Despite the progress made in recent years, there remain several significant challenges to be overcome to mainstream green and sustainable finance, including: ●●

policy and regulatory challenges

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economic challenges

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a lack of coordination and consistency

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data challenges

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capacity, capability and cultural challenges

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preventing and avoiding greenwashing

The objective of the COP26 Private Finance Strategy is to ‘ensure that every professional financial decision takes climate change into account’. Only when this is the case will we be able to say that green and sustainable finance has been genuinely mainstreamed, and finance aligned with the objectives of the Paris Agreement. This requires the adoption and implementation of a global framework focusing on four areas: reporting, risk management, returns and mobilization – which we have explored throughout this book. In addition, several wider environmental and other aspects of sustainability are emerging as areas of concern, interest and opportunity for policymakers, regulators and the finance sector. Two areas in particular that Green and Sustainable Finance Professionals should be aware of, and follow developments in, are: a nature-based finance – i.e. finance that recognizes our dependency on nature, seeking to conserve and benefit the environment and nature; and b ocean finance – which may be considered as a subset of the former, but is of sufficient importance to be treated separately. Building capacity, capabilities and cultures aligned with sustainability within financial institutions, and across the finance sector as a whole, is critical to aligning finance with the objectives of the Paris Agreement, and to addressing emerging, wider areas of environmental and social sustainability. Capacity, capability and culture, especially professional expertise and scepticism, are also important defences against greenwashing, which can damage market integrity, consumer and investor confidence, and slow the growth of green and sustainable finance.

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Table 12.1  Key terms Term

Definition

Biodiversity

The full range of ecosystems, species and gene pools – all plant and animal life found on Earth, and the habitats in which they live.

Blue economy

The economic activities supported by our oceans including, but not limited to, sectors such as aquaculture, fishing, shipping, tourism; and renewable energy that relies on oceans, including tidal and wave power, and offshore wind.

Blue finance

Lending, investment and underwriting activities that support the ‘blue economy’ – also referred to as ‘ocean finance’.

Convention on Biological Diversity (CBD)

The United Nations Convention on Biological Diversity launched at the UN Conference on Environment and Development in 1992, which entered into force in 1993 and has been ratified by 196 countries. The main global agreement and framework to address biodiversity loss.

COP26 Private Finance Strategy

A roadmap to support the alignment of private finance with the objectives of the Paris Agreement, set out in Building a Private Finance System for Net Zero – Priorities for Private Finance for COP26 by UN Special Envoy for Climate Action and Finance Mark Carney. Its objective is to ensure that ‘every professional financial decision takes climate change into account.’

Finance for Biodiversity Pledge

Established in 2020, and with nearly 100 signatories (as of 2022), the Pledge provides a forum for the sharing of best practice, and a supportive community of professionals and institutions with a common interest in addressing biodiversity loss through collective action.

Green Finance Education Charter

Launched in 2020, the Charter is an alliance of 12 leading Chartered and professional bodies committed to developing and mainstreaming qualification and CPD programmes that incorporate green and sustainable finance principles and practice.

Natural capital

The stock of natural assets, including air, water, land and all living things.

Nature-based finance

Finance that recognizes our dependency on nature, and seeks to conserve and benefit the environment and nature.

Nature-based solutions

Defined by the International Union for the Conservation of Nature as ‘. . . actions to protect, sustainably manage, and restore natural or modified ecosystems that address societal challenges effectively and adaptively, simultaneously providing human well-being and biodiversity benefits.’ (continued)

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Table 12.1  (Continued) Term

Definition

Ocean finance

Lending, investment and underwriting activities that support the ‘blue economy’ – also referred to as ‘blue finance’.

Partnership for Biodiversity Accounting Financials (PBAF)

Established in 2019 and currently (2022) comprising some 36 financial institutions, PBAF’s aim is to develop global standards for assessing and measuring positive and negative biodiversity impacts from financial institutions’ lending and investment activities.

Taskforce on Naturerelated Financial Disclosures

Established in 2021, the TNFD brings together financial institutions, governments, international organizations and NGOs to steer finance towards outcomes that are nature-positive.

Whilst international and national initiatives, and institutions large and small, have key roles to play in aligning finance with the objectives of the Paris Agreement and wider sustainability goals, so too do Green and Sustainable Finance Professionals, and finance professionals in general. The successful growth and development of green and sustainable finance depends as much, if not more, on the choices and decisions made by the individuals working within finance as on institutional and industry-wide initiatives. By enhancing their knowledge and understanding of and implementing green and sustainable finance principles and practice in their work, and encouraging others to do likewise in sufficient numbers, a purposeful culture that ensures that ‘every professional financial decision takes climate change into account’ (and broader aspects of sustainability, too) can be developed and sustained within financial institutions, and across the finance sector as a whole.

Notes 1 Principles for Responsible Investments (2022) Home, https://www.unpri.org (archived at https://perma.cc/UL79-H2AM) 2 UNEP FI (2022) Principles for Responsible Banking, https://www.unepfi.org/banking/ bankingprinciples/ (archived at https://perma.cc/L7WQ-ANZX) 3 UNEP FI (2022) Principles for Sustainable Insurance, https://www.unepfi.org/psi/ (archived at https://perma.cc/35Y3-LY5Q) 4 GFANZ (2022) Home, https://www.gfanzero.com (archived at https://perma.cc/ NWZ2-974Y) 5 The FC4S Network (2022) Home, https://www.fc4s.org (archived at https://perma. cc/7N2D-MF26)

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Green and Sustainable Finance 6 Climate Action 100+ (2022) Home, https://www.climateaction100.org/ (archived at https://perma.cc/EF7B-TY92) 7 United Nations Climate Change (2021) The Glasgow Climate Impact: Key outcomes from COP26, https://unfccc.int/process-and-meetings/the-paris-agreement/the-glasgowclimate-pact-key-outcomes-from-cop26 (archived at https://perma.cc/R2XS-3DC6) 8 Carney, M (2020) Building a private finance system for net zero: Priorities for private finance for COP26, https://ukcop26.org/wp-content/uploads/2020/11/COP26-PrivateFinance-Hub-Strategy_Nov-2020v4.1.pdf (archived at https://perma.cc/8EMS-WLF4) 9 Gaspar, V and Parry, I (2021) A proposal to scale up global carbon pricing, https://blogs. imf.org/2021/06/18/a-proposal-to-scale-up-global-carbon-pricing/ (archived at https:// perma.cc/WU8Y-UEW7) 10 UN Sustainable Goals (2022) UN Report: Nature’s dangerous decline ‘unprecedented’; species extinction rates ‘accelerating’, https://www.un.org/sustainabledevelopment/ blog/2019/05/nature-decline-unprecedented-report/ (archived at https://perma.cc/ JNF3-YNZC) 11 WWF (2020) Well. . . this is the million-dollar question. And one that’s very hard to answer, https://wwf.panda.org/discover/our_focus/biodiversity/biodiversity/ (archived at https://perma.cc/ND47-5HKW) 12 ELD, UNEP, Vivid Economics, WEF (2021) State of Finance for Nature, https://www. unep.org/resources/state-finance-nature (archived at https://perma.cc/E4DH-BLT9) ­13 HM Treasury (2021) Final Report: The Economics of Biodiversity: The Dasgupta Review, https://www.gov.uk/government/publications/final-report-the-economics-ofbiodiversity-the-dasgupta-review (archived at https://perma.cc/RH6D-ATPZ) 14 World Economic Forum (2020) Nature Risk Rising: Why the crisis engulfing nature matters for business and the economy, https://www3.weforum.org/docs/WEF_New_ Nature_Economy_Report_2020.pdf (archived at https://perma.cc/2F44-KAHQ) 15 WEF; AlphaBeta (2020) The future of nature and business, https://www3.weforum.org/ docs/WEF_The_Future_Of_Nature_And_Business_2020.pdf (archived at https://perma. cc/FE76-AWV8) 16 Antoine, G et al (2021) A ‘Silent Spring’ for the Financial System? Exploring biodiversity-related financial risks in France (Working Paper Series no. 826), Banque de France, https://publications.banque-france.fr/en/silent-spring-financial-system-exploring-­ biodiversity-related-financial-risks-france (archived at https://perma.cc/78LY-YR78) 17 Kok, M et al (2020) Indebted to nature – Exploring biodiversity risks for the Dutch financial sector, De Nederlandsche Bank, https://www.dnb.nl/media/4c3fqawd/indebtedto-nature.pdf (archived at https://perma.cc/B3MP-PHCW) 18 HM Treasury (2021) Final Report: The Economics of Biodiversity: The Dasgupta Review, https://www.gov.uk/government/publications/final-report-the-economics-ofbiodiversity-the-dasgupta-review (archived at https://perma.cc/RH6D-ATPZ) 19 ELD, UNEP, Vivid Economics, WEF (2021) State of Finance for Nature, https://www. unep.org/resources/state-finance-nature (archived at https://perma.cc/E4DH-BLT9) 20 IUCN (2016) Defining Nature-based Solutions, www.iucn.org/our-work/nature-basedsolutions (archived at https://perma.cc/TJP2-62U5) 21 Convention on Biological Diversity (2022) Home, https://www.cbd.int (archived at https://perma.cc/KW96-KXB7)

The future of green and sustainable finance 22 UN (2021) Convention on Biological Diversity, key international instrument for sustainable development, https://www.un.org/en/observances/biological-diversity-day/convention (archived at https://perma.cc/HQ7C-82AX) 23 Business for Nature; Convention on Biological Diversity, Finance for Biodiversity, PRI, UN Environment Program: Finance Initiative (2021) Financial Sector Guide for the Convention on Biological Diversity: Key actions for nature, https://www.cbd.int/ doc/c/8e24/f151/326b69024f014a8fb9684a8d/cbd-financial-sector-guide-f-en.pdf (archived at https://perma.cc/W889-SVMQ) 24 Ibid 25 Finance for Biodiversity (2022) About the Pledge, https://www.financeforbiodiversity.org/ about-the-pledge/ (archived at https://perma.cc/ABY9-CLQD) 26 Ibid ­27 Taskforce on Nature-related Financial Disclosures (2022) Home, https://tnfd.info (archived at https://perma.cc/23PH-Z8NP) 28 Partnership for Biodiversity Accounting Financials (2022) Home, https://pbafglobal.com (archived at https://perma.cc/LT55-X3QY) 29 PBAF (2022) PBAF Standard v2022, https://pbafglobal.com/standard (archived at https:// perma.cc/75Z6-2BC5) 30 Adapted by the author from Chartered Banker magazine (2021) Autumn 2021 Edition, www.charteredbanker.com (archived at https://perma.cc/N28J-4M3W) (for members only) 31 UNEP FI (2021) Beyond ‘Business as Usual’: Biodiversity targets and finance, https:// www.unepfi.org/publications/banking-publications/beyond-business-as-usual-­ biodiversity-targets-and-finance/ (archived at https://perma.cc/W8X9-KT28) 32 UNEP FI (2022) Sustainable Blue Finance, https://www.unepfi.org/blue-finance/ (archived at https://perma.cc/SL6L-YQ89) 33 OECD (2016) The Ocean Economy in 2030, https://www.oecd.org/environment/ the-ocean-economy-in-2030-9789264251724-en.htm (archived at https://perma.cc/ WD42-G8YS) 34 UNEP FI (2021) Turning the Tide: How to finance a sustainable ocean recovery, https:// www.unepfi.org/publications/turning-the-tide/ (archived at https://perma.cc/L4QB-8AB9) 35 UNEP FI, Sustainable Blue Economy (2022) Join Us, https://www.unepfi.org/bluefinance/join-us/ (archived at https://perma.cc/842K-3N2E) 36 UNEP FI (2018) Sustainable Blue Finance, The Principles, https://www.unepfi.org/bluefinance/the-principles/ (archived at https://perma.cc/Q8NQ-2G8K) 37 Credit Suisse (2021) How active engagement can contribute to ocean conservation, https://www.credit-suisse.com/ch/en/family-offices-und-hochvermoegende/philanthropieund-nachhaltige-anlagen/gemeinsame-zusammenarbeit/gemeinnuetzige-stiftungen/ wie-aktives-engagement-zum-schutz-der-weltmeere-beitraegt.html (archived at https:// perma.cc/DL92-BRDC) 38 Marine Capital (2022) Home, https://www.marine-capital.co.uk (archived at https:// perma.cc/J9PM-BSVQ)

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Green and Sustainable Finance 39 Asian Development Bank (2022) Ocean Finance Framework, https://www.adb.org/sites/ default/files/publication/777461/adb-ocean-finance-framework.pdf (archived at https:// perma.cc/34EG-R4Y8) 40 Chartered Banker (nd) Certificate in Green and Sustainable Finance, https://www.­ charteredbanker.com/qualification/certificate-in-green-and-sustainable-finance.html (archived at https://perma.cc/LSL5-TNTV) 41 Green Finance Institute (2022) What is the Green Finance Education Charter? https:// www.greenfinanceinstitute.co.uk/green-finance-education-charter/ (archived at https:// perma.cc/T3JS-G7BF) 42 London Climate Action Week 2021 (author’s own materials) 43 Chartered Banker Institute (2018) Chartered Banker Code of Professional Conduct, https://www.charteredbanker.com/resource_listing/cpd-resources/chartered-banker-codeof-professional-conduct.html (archived at https://perma.cc/R2KG-BUXD)

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INDEX The index is filed in alphabetical, word-by-word order. Numbers within main headings are filed as spelt out; acronyms are filed as presented. Page locators in italics denote information within a table or figure. absolute decoupling  91 Abundance Innovative ISA  290–91 accountability  4, 227, 277–78, 443, 615–16, 617 ACRE Africa  527 active investing  440–41, 459, 460, 465, 467, 489 acute physical risks  85, 215, 394 advisory services  4, 272–73, 274, 319, 407, 421, 516 afforestation 26, 28, 106 Africa  57–58, 119, 225, 286, 368, 527, 540 Africa Climate Change Fund  404 Africa Renewable Energy Fund  420 African Development Bank  404 aggregated funds  364 aggregated reporting  170, 190, 192, 198, 342, 395–96 agriculture  64, 73–74, 75, 77, 183, 297 see also farming AI (artificial intelligence)  537, 566, 567, 569 air pollution  53, 55, 169, 198, 308, 456, 512 airline sector  87, 90, 144, 254, 471 Alesco 518 Alipay  286–87, 537, 538, 560, 561 Alliance Trust Award for Circular Economy Investor 317 Allianz 516 Amazon  144, 537, 565 Armstrong 420 angel investing  477–78+ 489 Annex II Parties  193, 194, 201 annual CO(2)e  65, 174–76 annual reporting  169, 181, 225, 346 Ant Financial Services Group  286–87, 543, 560 Ant Forest  286–87, 543, 560, 561 Antarctic ice sheets  56, 72 anthropogenic climate change (human activity)  53–54, 57, 61–63, 68–73, 95, 97, 457, 575 Approved Verifier status  172–74, 353 apps  222, 286–88, 511, 537–39, 542–43, 545–46, 552 aquaculture 74, 175, 183, 298 Arabesque S-Ray®  550–51 Arctic ice sheets  56, 72, 74, 216 Asia  75, 83, 214 Asia Investor Group on Climate Change (AIGCC)  138, 139

Asia Pacific Loan Market Association (APLMA)  304, 306, 308, 311–12 Asian Development Bank (ADB)  352, 402, 404, 608 Asian Green Bond Fund  122, 364 assess-monitor-report approach  168–70 assessment reports (IPCC)  67 asset-backed securities  329, 367–69, 371 asset classes  122, 177, 195, 431–32 asset finance  316–17 Asset-Level Data Initiative  198, 201 asset stranding  85–87, 98, 215, 220, 224, 234, 263, 450, 455 atmosphere 59–64 Australia  57, 138, 223, 254, 291–92, 296, 306–08, 310, 317–18, 337 Austria  78, 129, 470 automation  458, 539, 541, 542, 552, 553–54, 566–67 BaFin  451, 577 Banco Central do Brasil  131 Bangladesh  388, 502 Bank Australia  296 Bank for International Settlements  121–22, 364, 383, 387 Bank of America  362 Bank of Åland  288, 545 Bank of England  251, 255, 256, 382, 384, 387, 390, 400, 451 Climate Biennial Exploratory Scenario (2021)  246–48, 397–98 Bank of Japan  388 banking sector  195, 228, 251, 269–23, 380–25, 538, 539, 544–49 Banque de France  131 Barclays 292–93, 362, 364, 365–66 BASE  521, 522 Basel Committee on Banking Supervision (Basel III) 121–23, 155, 252 baseline data  170, 280 basic needs metrics  185 batteries  13, 29, 31, 510 BBO 368 BBVA  150, 314, 549, 561 below 2°C scenario analysis  235 benchmark bonds  367

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Index Berkeley Energy  418–20 bespoke products  411, 413–15, 514, 515 best-of-class indices  461, 462 Bettervest  545, 546, 547 bias  45, 386, 458, 462–63, 485, 566, 567 Biden, President Joe  133, 218, 251, 340 big data  481, 537, 539, 544, 550, 562, 566 biodiversity  46, 560, 601–04 biodiversity loss  53, 55–56, 74, 248–49 biodiversity protection  28, 127, 184, 257, 627 biogeochemicals flows  54, 55 biosphere  54, 55, 59, 61, 62 Bitcoin  538, 555, 556, 565, 568 BlackRock  365–66, 445, 455, 472, 503 blended finance (co-financing)  411, 423, 424, 583–84 blockchain  300, 538–39, 540, 541, 543, 548–49, 552, 556, 562, 569 Bloomberg Barclays MSCI Green Bond Index  362, 364, 365–66 blue bonds  352, 371 blue economy (finance)  352, 605–08, 627, 628 BNP Paribas  150, 310, 333–34, 357 board members  148–49, 610 bond investors  330 bond maturity  330 bond yield  330, 350 bookrunners 318 BP  34, 66, 90, 482 Brazil  119, 131, 223, 337, 406, 408, 504 brown penalty factors  390, 391, 392–93, 504 brown products  13, 14 Brundtland Report  6 Build Back Better  8, 89–90 Bulgaria 517 business as usual approach  82–83, 165 Business Avengers  40 business impacts  243–44, 521 C-Change Discount (Ecology Building Society) 293 cable losses  520 Canada  119, 140, 223, 239 capability/capacity building  421, 591–92 capex-based systems  331, 580 capital markets  547–49 capital requirements  252, 253, 390–93 car sector  220, 296–97 see also electric vehicles carbon accounting  176, 177, 203, 252, 600 carbon border taxes  256, 262 carbon bubble  86, 97 carbon budgets  63, 86, 111–12 carbon capture and storage  27, 80, 97, 108, 112, 144, 241, 256, 257 carbon capture utilization and storage  80, 97

carbon credit delivery insurance  523 carbon credits (cap-and-trade schemes)  188, 254, 262, 474, 523, 587 carbon dioxide (CO(2)  15, 25, 27, 31, 63, 70–71, 108, 291–92 carbon dioxide equivalent (CO2e)  65–66, 169, 174–76, 201 Carbon Disclosure Project (CDP)  138, 176–77, 188, 200, 201, 442, 449, 468 carbon exposure index  274 carbon footprint trackers  287–88, 539, 545–46 carbon leakage  256 carbon neutral  106, 107, 108, 131, 155, 188, 257 carbon offsetting  254, 257–59, 262, 509, 513–14 carbon pricing  217, 241, 253–56, 262, 450, 587 carbon sequestration  80–81, 106, 299, 602 carbon sinks  79, 81 carbon taxes  133, 254, 259, 587 Carbonplace 259 Caribbean Catastrophe Risk Insurance Facility 524–25 Carlsberg, ‘Together Towards ZERO’ programme 40 Carney, Mark  1, 18, 86, 116, 150, 384, 457 Castlefield  468, 481–83 Caucasus Clean Energy  420 Central America  58, 420, 525 central banks  271, 380–401, 424, 539, 577 Centre for Greening Finance and Investment  197 Certificate in Climate Risk  228, 612 Certificate in Green and Sustainable Finance  2, 153 certification 172, 202, 314, 470 Certified Climate Bonds  337, 353 Chartered Banker Institute Code for Green and Sustainable Finance Professionals  616–19 chemical hazards  34, 35, 54, 93, 255, 299, 310 Chevron  66, 222 Chile 336, 337 China  15, 119–20, 131, 224, 255, 286, 287, 456 emissions reduction  107, 108, 109, 576 FinTech  286, 543, 555, 563 floods  58, 75 green bonds  131, 336, 337, 346–47, 389, 400 Green Credit Policy  399 insurance sector  511, 528 People’s Bank of China  131, 251, 337, 346, 347, 352, 387, 388, 389, 399–400 China Banking Regulatory Commission  399 China Development Bank  402, 407, 408 China Securities Regulatory Commission  337, 346–47 China Utility-Based Energy Efficiency Finance Program 416–17 chronic physical risks  85, 215, 262 circular economy  92–94, 97, 127, 316–17

Index Citadel 475 Citizens’ Assembly on Climate Change  112 Clean Technology Fund  412–13 clean transport see green transport (clean transport) CleanTech (GreenTech)  274, 297, 540, 569 ClientEarth 224–25 climate 57, 97 climate action  43 climate action failure  210, 211–12 Climate Action 100+  30, 87, 139, 443–44, 581 Climate Action Tracker  108 Climate Awareness Bond  335 climate bonds  352–53, 371 Climate Bonds Initiative  16, 136, 332–33, 335, 336, 348 Climate Bonds Standard  136, 170, 172, 173–74, 291, 353, 371 Climate Chain Coalition  562 climate change  53, 57, 97 Climate Change Act (2008)  111–12 Climate Change Act (2009)  112 climate change adaptation  8–9, 16, 19, 46, 77–78, 119, 126, 194, 527 Climate Change Committee (ING)  228 Climate Change Committee (UK)  111, 112, 291 climate change mitigation  8, 9, 15–16, 19, 46, 79–80, 107, 119, 193–94, 509 Climate Change 2021 (IPCC)  67, 69, 70–72, 85–86, 97, 111 Climate Change 2022 (IPCC)  68, 73–76, 97 Climate Credit Card  285–86 Climate Disclosure Project  149–50, 179–80 Climate Disclosure Standards Board (CDSB)  178, 179–80, 186, 201 climate finance  11, 19 Climate Financial Risk Forum  197, 251 Climate Hub  133 climate insurance (climate risk insurance)  16, 78, 508, 523–30, 532 Climate Investment Funds  412–13 Climate KIC  563 climate neutral  106, 107, 129, 155 Climate Policy Initiative  16 Climate-related Disclosures (ISSB)  178–79 climate resilience  528–30 climate resilience bonds  348 climate risk protection gap  528–30, 532 climate scenarios  68, 240, 242–43, 246–48 Climate-Smart Lending Platform  299–300 Climate Transition Finance Handbook  358 ClimateWise (ClimateWise Principles)  141, 502–03 Climetrics  468, 469 closed-ended funds (investment trusts)  364, 464, 466, 490 cloud computing  565

cloud formation  60, 61 co-financing (blended finance)  411, 423, 424, 583–84 Co-Op Insurance  509, 512 coal sector  189, 221–22, 255, 256 Coalition of Finance Ministers for Climate Action 123 coastal communities  56, 61, 74–76, 215–16, 515, 523, 596, 602, 605, 608 Cogo  539, 563 Collective Commitment to Climate Action  279–81 Colonnade 517 Commerce International Merchant Bankers Berhad 288–89 commercial banking  195, 251, 270, 282, 388, 417, 422, 423 commercial insurance  508, 514–23 commercial real estate lending  312–13 Commonwealth Bank of Australia  310 community investing  461 company tracker app  552 company valuations  219 concessionary loans  412–13 confidentiality  342, 606, 619 conflicts of interest  172, 618 construction insurance  518 consumer (customer) preferences  36–37, 217, 221–22, 240, 283–84, 448, 456–58, 486, 542 consumer cyclical sector  476 consumption paradigm  91 Convention on Biological Diversity  597–98, 627 cooperative banks  282 COP (Conference of the Parties)  109, 155, 597 COP21  79, 109 COP23  141, 525–26 COP26  64, 110, 574, 576, 582–84, 627 coral reefs  74, 352, 515, 605 Corbetti volcanic caldera  418 corporate banking (investment banking)  228, 269, 271, 272, 273, 293, 301–19, 321, 547–49 Corporate Bond Purchase Scheme  387 corporate bonds  384–87 corporate insurance  514–23 cost-shifting 91 Costa Rica  108 cotton industry  93 coupons (bonds)  329, 354, 362, 370 covenants  168, 169, 354, 370 Covid-19 pandemic  90, 110, 215, 285, 335, 355, 513, 537 credit allocation policies (credit guidance policies) 388–89, 424 credit cards  282, 285–86, 539, 545 credit databases  399 credit extension  282 Crédit Foncier  408

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Index Crédit Mobilier  408 credit quotas (floors)  388 Credit Suisse Green Bond Global Blue Index Fund 364 credit unions  282, 283 crop insurance  553–54 cross-cutting risks (transverse risks)  84, 151, 208, 209, 212, 213, 226, 227, 595 crowdfunding sites  538, 545, 546–47, 569 cruelty-free products  29 cryosphere  59, 62, 72 cryptocurrencies (cryptoassets)  538, 554–56, 564–65, 568, 569 see also GovCoins Cumulus Climate Fund  475 Cumulus Energy Fund  475 Cumulus Fahrenheit Fund  475 current accounts (checking accounts)  284–85, 286 current policy scenarios  235 Cyclone Amphan  58 Cyclone Pam  525 Dasgupta Review (2021)  248, 595, 596 data  170, 196–98, 234, 280, 505, 545, 589–91 see also big data data analytics  468–70, 481, 539, 547, 550–52, 566 data privacy  566 data providers  197, 590 De Nederlandsche Bank  248, 400 de-growth 92, 97 debit cards  285 debt capital  328–31, 432 debt capital markets  329 decarbonization  30, 32, 46, 86, 115, 189, 221, 272 decent work metrics  185 decoupling 91, 97 dedicated assets  446 deep (dark) green strategies  13, 14, 38, 146–47, 155, 441–42 deforestation  53, 54, 144, 241, 447, 576 delayed transition scenarios  235 demand deposit (current) accounts  284–85, 286 demographics  414, 456 Denmark  30–31, 106, 254 deposit taking  281, 291, 317–18 Development Bank of Japan  338, 413 Development Bank of Southern Africa  339 development banks  380, 402–22, 423–24 digital currencies (cryptocurrencies)  538, 539, 554–56, 564–65, 568, 569 digital exclusion  565–66, 569 digital finance see FinTech digital payment systems  281, 286–87 direct banking  291 direct GHG (scope 1) emissions  66, 167, 176, 257

direct impacts  165 disclosures  19, 280, 305, 399–400, 451–53, 463 see also Carbon Disclosure Project (CDP); Climate Disclosure Standards Board (CDSB); Task Force on Climate-related Financial Disclosures (TCFD); Task Force on Nature-related Financial Disclosures (TNFD) discounts  22, 292–93, 296, 509, 512, 513 discrimination  39, 559, 566 disorderly divergent net zero scenario  235 disorderly (late action) climate scenarios  234, 246, 247, 398 distributed ledgers see blockchain diversity  149, 184, 457 divestment (disinvestment)  30, 44, 46, 87, 221, 456 DLL, Clean Technology Financing (Life Cycle Asset Management)  316–17 Doconomy 539 documentation  305, 453 domestic insurance  511–13 DONG Energy  30–31 double materiality  165, 200, 202 Dow Jones  460, 461, 471, 506 drought  57, 61, 70, 107, 108 due diligence  168–69, 603 duty of care  224 dyeing 93 early action (orderly) scenarios  234, 235, 246, 247, 256, 397 Earth’s energy balance  59–61 eco-fashion (ethical fashion)  28, 29 eco-friendly products  29 EcoAct 459–60 Ecology Building Society  23, 290, 293 economic impact  9–10, 35, 37, 38, 41–42, 82–84, 184, 189, 214, 587 EcoSave savings account (CIMB) 288–89 Ecosummit 477 EDF 343 education sector  37, 42 Egypt 422 Ekobanken 284–85 El Niño  61–62 electric vehicles  13, 295–97, 509–10 embedded organizational approach  24, 34, 46, 142–153, 155, 227, 271–72 Emerging Energy Latin American Fund II  419 emissions trading schemes  254–56, 262, 523 EnBW New Ventures  477 Enea 224 Energiewende policy  413–15 energy distribution (grids)  26, 27, 314, 512, 517, 518

Index energy efficiency  26, 27, 92, 175, 194, 293–95, 298, 447 energy efficiency insurance  512, 520–23, 532 energy performance  292, 417, 512, 516, 521 Energy Performance Certificates  292, 512 Energy Saving Trust  296 Energy Savings Insurance  521–22 energy storage  27, 29, 318, 540 Energy Transition and Green Growth Act (2015) 131 Engine No.1  445 ENSO cycle  61–62 entrepreneurs  44, 297, 355, 477, 514, 526 Environment (Wales) Act (2016)  112 environmental awareness  457 Environmental Finance IMPACT Awards  310 environmental impacts  9–10, 29–30, 35, 54–56, 184, 196–98, 223–25, 433 environmental insurance  508, 532 Environmental Sustainability Bonds  348, 404 equality 37, 38, 39, 40, 43, 73, 184, 311, 404 Equator Principles (EP4)  135, 166 equilibrium climate sensitivity  242 equity indices  460–63 equity investment  421, 431, 489 equity markets  458–63 ESG  9–10, 130, 131, 181, 197, 228–29, 433–34 see also environmental impacts; ESG investing; governance; social impacts ESG Committee (ING)  228–29 ESG indices  461, 466 ESG investing  21, 149, 153, 360–61, 433–34, 440–41, 452–55, 457, 489, 612 ESG-linked Subscription Credit Facility (EQT) 311 ESG Risk Centre of Expertise (ING)  229 Ethereum  538, 554, 555, 556 Ethical Consumer  146 ethical investment  434, 489 ethics  42, 434, 489, 613 Euronext  338, 359, 360–61 European Bank for Reconstruction and Development (EBRD)  335, 347–48, 402, 404, 422 European Banking Authority  130, 251, 390, 393, 396–97, 577 European Central Bank (ECB)  123, 130, 384, 385, 387, 395–96 European Commission  107, 126, 128–29, 390, 391–93, 418, 441, 484, 504, 577, 605 European Consumers’ Association  129 European Energy Efficiency Mortgage (EMF)  294 European Green Deal  89, 90–91, 126, 345, 391, 505, 576 European Insurance and Occupational Pensions Authority  130–31, 251, 501, 504, 577

European Investment Bank (EIB)  23, 129, 335, 386, 403–04, 413, 421, 605 European Securities and Markets Authority  130, 451, 455, 577 European Sustainable Investment Forum (Eurosif)  129, 139 European Union (EU)  78, 110, 119, 223, 451, 461 Action Plan for Financing Sustainable Growth  125, 345, 390–92 Carbon Border Adjustment Mechanism  256 Ecolabel  125, 470 Emissions Trading System  254–55 Green Bond Standard  14, 15, 125, 333, 345–46 green bonds  336, 355 Horizon 2020 Programme  294 Solvency II  156, 504 Sustainable Finance Action Plan  124–25 Taxonomy  14–15, 26, 125, 126–29, 192, 193, 252, 333, 345 2030 Climate Target Plan  107 see also European Commission; European Green Deal; Non-Financial Reporting Directive; Sustainable Finance Disclosures Regulation (SFDR) evaluation criteria  305–06, 307, 341, 342, 346, 349 evapotranspiration  60, 61 Every Action Counts coalition  560–62 Evolution One  419 exchange rate fluctuations  329, 499 exchange traded funds (ETFs)  365, 471–74, 490 exchange traded funds (ETFs) Database  474 executive pay (remuneration)  149–50 exit timeframe  476 Expert Panel on Sustainable Finance  134 exploitation (of women/girls)  39 export-import banks (export credit agencies)  403 external reviews  170–72, 202, 332, 334, 341–46 externalities 35, 98, 219, 253–54, 485, 587 extractive industries  19, 82 see also coal sector; oil sector extreme weather  16, 57–59, 75, 85, 210, 214–15, 501–03, 523 ExxonMobil  66, 222, 392, 445 Fairness  613–14, 618 Fannie Mae  340, 368 farming  93, 299–300, 526–28, 540, 553–54 see also agriculture fashion sector  28, 29, 357 fast-food sector  144 FC4S  141, 581 Federal Reserve  133, 251, 381 female investors  456–57

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638

Index Ferrel cell  59 fiduciary duty  33, 43, 483–84, 489, 490 Fifth Basic Environment Plan (2018)  133–34 Fiji  336, 554 Finance for Biodiversity Pledge  561, 598–99, 600, 627 finance flow tracking  191–96 Finance Sector Expert Group  106 FinanCE Working Group  94 financial advisers  468 Financial Conduct Authority  148, 251, 451, 452–53, 563–64 Financial Conduct Authority Sandbox (regulatory sandbox) 563–64, 570 Financial Innovation Laboratory  131 financial stability  381, 383 Financial Stability Board (FSB)  86, 120, 212, 215, 231–33, 262, 424 Financial Stability Climate Committee  251 financing green  12, 272–75, 320 Finland  254, 288, 416, 545 FinTech  281, 286, 299, 300–01, 447–48, 469, 477, 536–72 FinTech4Good 562 first loss provision  334–35, 417–20 first-party reviews (self-certification)  173, 306 fixed income  328–31, 432 fixed income markets  329 flooding (flood prevention)  16, 55, 58, 75, 76, 78, 108, 214 Florida 76 food security  38, 77, 608 forcing agents  57, 59–62 forestation  38, 80–81, 225 forward-looking data  197, 234, 505 fossil fuels  8, 15, 18–19, 46, 63–64, 66, 86–87, 189, 274–75, 461 France  106, 119, 129, 131–32, 239, 254, 336, 338, 451, 596 IRS Label  470 Frankfurt Main Finance  563 Franklin Liberty Euro Green Bond ETF  365 Friends of the Earth  90, 92, 128–29 Frontier 419 FT Russell  463 F3 Life  299–300 FTSE 100 companies  459–60, 471 FTSE TPI Climate Transition Index  463, 465, 471 Fukushima Daiichi nuclear disaster  133 fund labelling  125, 145, 345, 464–65, 470, 471, 474, 490 fusion projects  519 Future World Girl Fund  482 gamification 287 gas sector  13, 86–87, 127, 128–29, 189, 293

GBTI Bank  302–03 GCash Forest  561 gender equality  37, 38–40, 42, 142, 149, 300, 311, 404, 457, 482 general insurance  498, 508, 515–16, 531, 532 general partners  476 General Requirements for Disclosure (ISSB)  178–79 Germany  129, 132, 336, 338, 413–15, 470, 477, 546, 563 BaFin  451, 577 glacial retreat  56, 71, 72, 74–75 Glasgow Financial Alliance for Net Zero (GFANZ)  23–24, 113, 116–18, 156, 187, 576, 581 Global Alliance for Banking on Values  137–38, 284 Global Banking Development Forum  409 Global Energy Efficiency and Renewable Energy Fund 418–20 global financial crisis  6, 7, 389–90 Global GHG Accounting and Reporting Standard 177, 203 Global Impact Investing Network  140, 184, 202, 438, 442 Global Sustainability Standards Board  183–84, 202 Global Sustainable Investment Alliance  16, 139–40, 448 Global Sustainable Investment Review  140 Global Trade Finance Program  316 global warming  15, 68, 70, 73–76, 216 global warming potential  65 Google  40, 565 GovCoins  539, 554 governance  10, 148–49, 179, 277, 305, 307, 433 risk  226–27, 228–29, 237, 238, 250, 394–97 government bodies  104, 105–08, 145 grants 420 Green and Blue Bond Framework (ADB)  352 Green and Sustainable Finance Certificate  610 Green Angel Syndicate  477–78 green asset ratio  251 Green Assets Wallet Initiative  547–48 Green Bond Endorsed Project Catalogue  131, 337, 347, 400 Green Bond Framework (EDF)  343 green bond fund management  341, 346, 349 green bond funds  363–67 green bond indices  361–67, 371 Green Bond Issuance Promotion Platform  338 Green Bond Principles  135–36, 332–33, 340–44, 372 Green Bond Standard  14, 15, 125, 333, 345–46 green bonds  16, 30–31, 129, 144, 328–79, 389, 390–91

Index green buildings  27, 293, 294, 447, 512 Green Climate Fund  119, 289 green convertible bonds  335 green development banks  402–03, 409–10, 413, 424 Green Digital Finance Alliance  538, 547, 560–62 green economy  88, 98 Green Economy Transition (EBRD)  404 green exchangeable bonds  335 green finance, defined  10, 11–12, 21–22, 45, 47 Green Finance and Investment Forum  603–04 Green Finance Education Charter  152–53, 611–12, 627 Green Finance Framework (Macquarie)  306–07 Green Finance Impact Report (Macquarie)  308 Green Finance Institute  293, 409 Green Finance Network Japan  134 Green Finance Study Group  120 Green Finance Taxonomy (South Africa)  132 Green Finance Working Group (Macquarie)  307 Green FinTech Challenge  563–64 Green FinTech Network  564 Green Future Deposit Certificates  289–90 Green Gilts  336, 339 green growth  90–92 Green Home Finance Principles  293 green insurance  508–35 Green Investment Group (Bank)  168–70, 403, 409, 410, 421 Green Lending Initiative  313 Green Loan Principles  136–37, 170, 302–08, 321, 322 green loans (lending)  22, 25, 78, 246, 295–302, 312–13, 322, 412–15 measurement  186–90, 192, 195 green mortgages  22, 25, 28, 291–95, 322, 368–69, 392 Green New Deal  90 Green, Social and Sustainability Bond Framework (NatWest)  343, 349 green sukuk  358–59, 372 green supporting factors  390–92, 425 green tagging  192, 198, 292, 295, 322 Green Tailored Deposit Scheme  317–18 Green Term Deposits  291 green transition bonds  348 Green Transition Project Portfolio  348 green transport (clean transport)  26, 27, 176, 256, 336, 339, 447 see also electric vehicles green upgrade insurance  512 greenhouse effect  63–67, 98 Greenhouse Gas Protocol  65–66 greenhouse gases (GHG)  15, 55, 63–68, 70–71, 98, 107–08, 167, 174–80, 195–96, 257 see also carbon dioxide (CO2); methane (MH4)

greening finance  12, 271–72, 320 greenium  350, 370, 372 Greenland ice sheets  56, 72 Greenpeace  90, 128, 242, 565 GreenTech (CleanTech)  274, 297, 540, 569 GreenTech Festival  540 greenwashing  20–21, 34, 47, 129, 144–46, 155, 223, 258, 318, 592–94 bonds markets  332, 351 investment funds  464–65, 480–83 GRI (Global Reporting Initiative)  178, 181, 183–84, 202 gross value added paths  397, 398 G7  179, 239, 336, 382, 529, 576, 588 G20  119–20, 131–33, 401, 522 guarantees  403, 415–17 Guyana 303 H&M 357 habitat loss (protection)  28, 53, 271 Hadley cell  59 health impacts  37, 39, 42, 59, 75–76, 93 heat waves  70, 73, 75, 107 hedge funds  445, 464, 474–75, 490 Helsinki Principles  123 high-frequency trading  474, 538, 544 High-Level Champions for Climate Action  106 High-Level Expert Group on Sustainable Finance (HLEG)  125, 127, 391–92, 393 Himalayas  56, 74–75 hiveonline  300–01, 540 hot house world (no additional action) scenarios  234–35, 247, 248, 397, 398 Hothouse Earth  70 housing 293, 339, 355, 392 home insurance  511–13 HSBC (SDG Bond Framework)  297, 354 human activity (anthropogenic climate change)  53–54, 57, 61–63, 68–73, 95, 97, 457, 575 humanitarian blockchain  300, 540, 569 hurricanes  58, 501, 502, 515, 525 hybrid vehicles  302, 413, 509, 510 hydro power  519, 593 ice-cores 63 ice sheets  56, 71–72, 74, 216 impact analysis (assessments)  243, 277–78 impact calculator  482 impact investing (investors)  140, 181, 356, 431, 437–38, 441–42, 482, 490, 546 Impact Investing Institute  181, 438, 442 impact monitoring  166–70, 181, 202 impact underwriting  509–23, 532 improver investment strategies  446 incentives  9, 92, 149–50, 219, 272, 383

639

640

Index inclusion  4, 37, 38, 41, 404 independent (external) reviews  170–72, 202, 332, 334, 341–46 index  490 green bond  361–67, 371 index funds  471, 490 index insurance  526–28, 532 India  58, 93, 107, 109, 119, 223, 289–90, 338, 388–89, 577 carbon pricing  254, 255 insurance  527, 528 indirect GHG (Scope 2/Scope3) emissions  66, 167, 176, 180, 187, 237, 257 indirect impacts  165 individual level PRBs  279 Indonesia  61, 75, 119, 359, 561 industry level PRBs  278 inertia (status quo bias)  485, 486, 579, 604 ING  23, 190, 228–29, 302 initial public offerings (IPOs)  273, 318, 458, 476 Innovate Suite  563–64 Innovation Hub on Green Finance  122 Institute of Banking and Finance Singapore  132 Institute of International Finance  258–59 institutional investors  430, 432, 449, 459, 490, 499 Institutional Investors Group on Climate Change (IIGCC)  129, 138, 139 institutional PRBs  278 insurance  16, 78, 82, 214, 498–535, 553–54 insurance premiums  499, 517, 519 InsuResilience Global Partnership  141, 525–26 INsurTech  539, 553–54 intangible assets  223 integrated assessment models  3, 68 integrity  42, 613, 617 Integrity Council for Voluntary Carbon Markets 259 INTEGRITY model  3–4 Inter-American Development Bank  131, 303, 314, 402, 404–05, 521, 522 Inter-tropical Convergence Zone  77 intergovernmental bodies  104, 105–08, 145 Intergovernmental Panel on Climate Change (IPCC)  47, 57, 214, 291–92 AR5  65, 68–70 Climate Change (2021)  62, 67, 69, 70–72, 85–86, 97, 111 Climate Change (2022)  5, 62, 68, 73–76, 97 interim goals  107, 117, 189, 277, 280 International Association of Insurance Supervisors  501, 504, 507 International Capital Market Association (ICMA)  304, 355, 356–57, 373 Climate Transition Finance Handbook  358 Green Bond Principles  135–36, 332–33, 340–44, 372

International Carbon Reduction and Offset Alliance 258 International Development Association  405 International Energy Agency (IEA)  17, 80, 86, 242, 330 International Finance Corporation  316, 335, 405, 416–17 International Financial Reporting Standards Foundation (IFRSF)  178, 183, 186, 252 International Green Construction Code  512, 532 International Integrated Reporting Council (IIRC)  178, 181, 182–83, 186, 200, 202 International Monetary Fund (IMF)  179, 255, 450 International Network of Financial Centres for Sustainability  141, 581 International Organization for Standardization (ISO) 195–96, 202 International Organization of Securities Commissions (IOSCO)  121, 179, 439–40 International Sustainability Standards Board (ISSB)  163, 167, 176, 178–84, 186, 202, 203, 590 Internet of Things (IoT)  568, 570 interstate conflict  210 investment banking (corporate banking)  228, 269, 271, 272, 273, 293, 301–19, 321, 547–49 investment funds  464–75, 490 investment growth  448–49, 578 Investment Leaders Group  184–86 investment psychology  485–86 investment returns  454–56, 464 investment strategies  14, 16–19, 28, 43–44, 184–86, 429–97, 550–52 ESG  21, 149, 153, 361, 612 impact investing  140, 181, 356, 546 measurement tools  186–90, 192, 198 scenario analysis  246 investment syndicates  477–78 investment trusts (closed-ended funds)  364, 464, 466, 490 Investor Agenda  449 investor engagement see shareholder activism (very deep green strategies) investor sentiment  217, 221, 448 Inyova  469, 545 Framework (IIRC)  183, 202 IRIS (Impact Reporting and Investment Standards)  140, 184, 202, 442 IRIS+ Core Metrics  184, 442 ISAs 290–91 iShares Green Bond Index Fund  364, 365–66, 473 Islamic finance  288–89, 359, 434 ISO 14097  195, 196, 202 issuer risk  329 Japan  58, 119, 239, 254, 255, 338, 388, 413, 461 Basic Environment Plan  133–34

Index Japanese Financial Services Agency  134 Joint Research Committee (EU)  128 Jupiter Ecology Fund  466 just transition  9, 42, 47, 281, 297, 449 Kenya  57–58, 299–300, 368, 527, 528, 543 KPIs (key performance indicators)  137, 184, 312, 357, 548 Kreditanstalt für Wiederaufbau (KfW)  132, 338, 406–07, 408, 410, 413–15 Kyoto Protocol  79, 96, 109, 156 L&G (Legal and General)  365, 482 La Niña  61 land conservation (contamination)  26, 38, 54, 55, 112, 175, 185 late action (disorderly) climate scenarios  234, 246, 247, 398 leader investment strategies  446 leadership  39, 148–49, 155, 229, 455 leasing  296–97, 316–17 lending requirements  388 LendTech 539 leveraged buyouts  476 liability risks (litigation risks)  84, 85, 211, 216, 222–25, 260–61, 262, 450, 500–01 Life Cycle Asset Management  317 life insurers  507, 508, 532 light green strategies (positive screening)  143–44, 155, 156, 439–40, 441, 445–46, 490 limited partners  476 linear economy  92, 94 listed equities  449, 459–60, 464, 490 lithosphere 59 Lloyds Banking Group  297, 302, 313, 317 Lloyds of London  501 Loan Market Association (LMA)  304, 306, 308, 311–12 Loan Syndications and Trading Association (LSTA)  137, 308, 311–12 London Stock Exchange  337, 359, 361 long-term focus  4, 32–33, 35–37, 455 longwave radiation  59–61 loss of earnings insurance  516 Luxembourg Green Exchange  359–60, 361 LuxFlag 470 LV= (Liverpool Victoria)  510 Lycetts 519 M-KOPA 543 M-Pesa  286, 543 machine learning  197, 537, 550, 566, 570 Macquarie  306–08, 409 macroprudential policy  122, 383, 389–90, 425 Make My Money Matter  87, 457–58

malaria 76 Malaysia  288–89, 307, 359, 382, 390, 403, 408, 409, 561 margin adjustment  309, 322 marginal costs  330, 331, 580 Marine Capital  608 marine conservation  352, 470 Marine Stewardship Council Label  470 market opportunities/risks  36, 85, 218, 396, 473 Mastercard  40, 561 material damage  520 measurement (metrics)  117, 163–207, 237, 238–39, 250, 442, 485, 551 meat substitutes (analogues/alternatives)  29 Merrill Lynch  362 Mesoamerican Reef  515 Metamask 556 methane (MH4)  46, 63–64, 65, 66, 70, 81, 95, 98 Mexican Development Bank  339 Mexico 119, 339, 354, 515, 521, 528 MGM Sustainable Energy Fund  420 Miami  76, 215 micro business loans  297–301 microfinance  282–83, 298–99, 300–01, 438, 446, 526, 541, 545, 559, 561 microprudential policy  383, 387, 394–98, 425 migration  75, 76, 210, 503 millennials  151, 449, 456 Minsky moment  217, 261, 262 mobile technology  40, 92, 281, 286–88, 299, 527, 537–38, 543, 545, 553–54 momentum investment strategies  14 Monetary Authority of Singapore  132, 251, 339, 564 monetary policy  381, 382–87, 401 money markets  431, 432 motor insurance  509–11 MSCI 197, 362, 364, 365–66, 454, 463, 471, 473 MSCI All Country World Index  219, 461 multilateral development banks (MDBs)  19, 23, 193, 271, 333–35, 402, 403–06, 420, 424, 425 mutual banks  282 Nacional Financiera  339 National Australia Bank  291, 337, 368 National Development and Reform Commission (NDRC)  346, 347 national development banks  132, 333, 334, 335, 402, 406–09, 424, 522, 578 National Employment Savings Trust  221 National Environment Agency  339 nationally determined contributions (NDCs)  79, 107, 108, 110, 112, 123, 156, 576, 582, 583 natural capital  91, 447, 596, 604, 627

641

642

Index natural disasters (catastrophes)  82, 210, 501–03 nature-based finance  594, 595–604, 605, 608, 626, 627 nature-based solutions  249, 596, 597, 627 Nature Conservancy, The  352, 515 Naturesave  23, 512, 513 NatWest  288, 343, 349, 355, 539 negative emissions strategies  15, 81, 106, 156 negative screening (very light green strategies)  433, 434, 437, 438–39, 490 net carbon footprint  30, 47 net zero  106, 112, 156, 189, 212 Net Zero Asset Managers Initiative  23, 113, 116, 117, 138, 142, 156, 576 Net Zero Asset Owner Alliance  113, 115, 142, 154 Net Zero Banking Alliance (NZBA)  115, 117, 154, 269, 272, 276, 279–81, 283 net zero carbon emissions  106, 156 Net Zero Financial Service Providers Alliance  113, 116, 117, 142 Net Zero Insurance Alliance  116, 117 Net Zero Investment Consultants Initiative  117, 142 Net Zero Investment Framework  138 Netherlands  248, 292, 295, 596 Network for Greening the Financial System (NGFS)  121, 133, 134, 156, 233–36, 246, 251, 261, 400, 577 new nature economy  249, 595–96 New York Metropolitan Transportation Authority 335 New York State Department of Financial Services 505 New Zealand  40, 106, 223, 238, 255 NGOs (non-governmental organizations)  129, 145–46, 218, 223, 224, 368–69, 540 Nigeria  224, 404, 565 nitrogen  10, 54, 64 nitrous oxide (NO2)  64, 65, 70–71, 95, 176 no additional (hot house world) scenarios  234–35, 247, 248, 397, 398 Non-Financial Reporting Directive (EU)  239 non-life (general) insurers  498, 508, 521, 532 Nordea Bank  288, 297–98, 364, 545–46 Nordic Swan Ecolabel  470 Northern Ireland Executive  112 Norway  20, 106, 220, 254, 416, 418, 419, 555, 594 nuclear power  127, 128–29, 133, 519 nudges  287, 542, 545 Nviro 519 Ocean Engagement Fund  608 ocean finance  352, 594, 605–08, 626, 627, 628 oceans  59, 61–62, 71–72, 74, 560

OECD (Organization for Economic Co-operation and Development)  91, 179, 193 Annex II parties  193, 194, 201 Green Finance and Investment Forum  603–04 Research Collaborative  194–95 Office of the Comptroller of the Currency  251 offshore wind farms  31, 112, 307, 330, 410, 414, 421, 519, 520, 580, 605 Oikocredit 368 oil sector  86–87, 169, 189, 224, 392 see also ExxonMobil OKO 553–54 older investors  456 open-ended funds  464, 466, 491 open sourcing  197, 591, 612 operational activities  36, 44, 518 opex-based systems  331, 580 orderly (early action) scenarios  234, 235, 246, 247, 256, 397 organization-guaranteed bonds (use of proceeds bonds)  329, 333–34, 352, 372, 373 organizational culture  3, 23–25, 147–53, 212, 227–28, 592 organizational strategy  23–25, 43–44, 179, 237, 238, 250, 276 embedded approach  34, 46, 142–53, 155, 227, 271–72 Ørsted 30–31 outcome monitoring  166–70, 181 outgoing radiation  59–61 oxygen  64, 605 Pacific Catastrophe Risk Assessment and Financing Initiative  524–25 Pacific Ocean  61–62 Pakistan  58, 561, 565 Paris Agreement  11, 17, 44–45, 47, 79, 88, 110–11, 191–93, 218 Article 2.1 (c)  1, 11, 151, 194, 195, 201, 580 monitoring  186–90, 194–96 Paris Agreement Capital Transition Assessment (PACTA)  187, 189–90, 203, 239 Paris Aligned Investment Initiative  117, 138, 576 partial credit guarantees  322, 415 partial risk guarantees  415 Partnership for Biodiversity Accounting Financials 600, 628 Partnership for Carbon Accounting Financials (PCAF)  176–77, 193, 200, 203, 239, 295 passive houses  512, 513 passive investing  459, 460, 465–66, 467, 490 Patagonia 146 patient capital  411, 425, 458, 484, 503 pay as you drive/ how you drive insurance  510–11 pay for performance contracts  355–56 PayTech 538

Index Peabody 221–22 peer-to-peer (P2P) lending  290–91, 297, 538, 545, 547, 570 Pensions Act (2021) (UK)  451–52 pensions funds  87, 451–52, 457–58 People’s Bank of China  131, 251, 337, 346, 347, 352, 387, 388, 389, 399–400 permafrost  59, 70, 72, 95 personal insurance  508, 509–14 physical risks  83, 85, 190, 211–12, 214–16, 262, 263, 394, 450, 502 planetary boundaries  54–55, 92, 98 plastic alternatives  29 Platform on Sustainable Finance  129 Polar cell  59 polar ice caps  56, 71 policies  85, 105–06, 117, 147–48, 381, 382–87, 401, 449, 575–78, 585–87 political risk  218–19, 331, 519 polluter pays principle  224 pollution  26–27, 34–35, 53, 55, 127, 169, 198, 308, 412, 456 Portfolio Carbon Initiative  66 portfolio tracker app  552 Positive Money  368–69, 400–01 positive screening (light green strategies)  143–44, 155, 156, 439–40, 441, 445–46, 490 post-growth (steady state) economies  91–92, 96, 98 poverty  38, 185, 283, 355, 523, 525, 614 power generation  19, 66, 330, 369 precipitation (rainfall)  55, 57–58, 61, 77, 85, 93, 527 price comparison sites  538 Priceless Planet Coalition  561 Principles for Responsible Banking  23, 40–43, 114, 272, 275–79, 322 Principles for Responsible Investment (PRI)  23, 114, 129, 138, 141–42, 435–37, 449, 491, 581, 589, 610 Principles for Sustainable Insurance  114, 506–07, 533, 581 private equity  117, 194–95, 311, 449, 475, 491 private equity funds  475–79 process monitoring  166, 203 product as a service approach  92 product design  92 professional development  4, 151–53, 279, 609–19 profit maximization  33–34, 35 Programme for Government  112 project bonds  334–35, 372 project finance  166, 314, 322 Project Greenprint  564 property and casualty (general) insurers  498, 508, 515–16, 531, 532 Prudential Regulation Authority  251, 451

public finance  117, 119, 194, 419–20 public savings banks  283 purpose-washing  20, 34, 320, 594 qualitative metrics  180–81 quantitative easing (QE)  383, 384–86, 425 quantitative (quantifiable) metrics  180, 181, 184, 188, 242 Quintet Private Bank  446 Rabobank  302, 316–17, 561 Race to Resilience  107 Race to Zero  106, 116, 117, 138, 142 rainfall (precipitation)  55, 57–58, 61, 77, 85, 93, 527 Rapanui 93 re-weighting 462 real estate  229, 312–13, 390, 431, 432 rebound effect  91 Reclaim Finance  128–29 recourse-to-the-issuer debt obligation  333 recruitment  7, 37, 143, 151, 591 recycling  29, 92, 93, 143–44, 302, 308, 318, 357, 478, 540 reef brigades  515 reforestation 26, 28, 106, 167, 175, 241, 287, 289, 561 RegTech 538 regulation  36, 104–06, 130–31, 219–20, 230–33, 249–52, 401, 575–78, 585–87, 617–18 insurance 504–05 investing 451–55 regulatory convergence  252 regulatory divergence  252–59 regulatory sandbox  563–64, 570 reinsurance  116, 130, 140, 499, 508, 518, 525, 533 relative coupling  91 remote sensors  196, 198, 590 remuneration  30, 149–50, 228, 459 renewable energy  9, 27, 47, 175, 193–94, 330–31, 336, 414–20, 461, 512–20 Renewable Energy Asia Fund  419 Renewable Energy Insurance Broker  517 reporting  163–207, 244, 278, 305–08, 312, 332, 341–42, 346, 349 Representative Concentration Pathways (RCPs) 68–70, 98 Repsol Energy  344 reputational risk  19, 36, 85, 217, 222–23 research and development  319, 447, 462, 563 Research Center for Green Economy and Sustainable Development  563 Reserve Bank of India  389, 577 reserve banks (central banks)  271, 380–401, 424, 539, 577

643

644

Index reserve requirements  389 residential mortgage-backed securitization  368 resource scarcity  185 responsibility  4, 615 responsible investment  435, 491 retail banking  270, 272, 281–301, 321, 322, 538, 539, 544–47 retail investors  19, 430, 432, 491, 538 retrofit mortgages  22, 293–95, 512, 580 revenue bonds  335, 361 ring-fencing (bonds)  332 risk  81–87, 225–26, 450–51, 473 risk appetite  226, 227–28 risk carrying  499 risk governance  226–27, 228–29, 237, 238, 250, 394–97 risk management  121–22, 179, 208–68, 390, 499, 528–30, 541 risk/reward trade-off  430–31 risk strategy  226 risk weightings  122, 389–93 RM1 billion  359 RM250 million  359 Rocky Mountain Institute  189, 409 Royal Dutch Shell  30, 66, 224, 240–41, 392, 471, 482 Rupununi Ventures  303 Russia  119, 382, 555 S&P  258, 362, 365, 465, 473 Santander UK  41–43 satellite technology  62, 196, 198, 287, 511, 527, 541, 548, 553–54, 590 savings products  288–91 scenario analysis  189–90, 234–35, 239–48, 261, 263 Science-Based Targets Initiative  188–89, 203, 257 scorecards 400–01 Scottish National Investment Bank  402, 407 Scottish National Performance Framework  40 screening indices  461 sea contamination  54 sea level rises  56, 71–72, 75, 76, 85 sea temperature  61, 71 SEB  273–74, 357 second-party reviews  172, 306 secondary trading of shares  458 sector standards  183 Securities and Exchange Commission  133, 251, 452, 505 securitization  329, 367–69, 371 self-certification (first-party reviews)  173, 306 senior management (leadership)  39, 148–49, 155, 229, 455 sensor technology  196, 198, 511, 512, 590 series losses  519–20

Seychelles  75, 352 shared socioeconomic pathways (SSPs)  68–70, 71, 98 shareholder activism (very deep green strategies)  442–46, 459, 491 shareholders 33–34 Sharia compliance  289, 358–59, 370 Shell  30, 66, 224, 240–41, 392, 471, 482 short-termism  4, 6, 31–33, 34, 35, 458, 484–86 shortwave radiation  59–61 Singapore  132, 239, 251, 339, 359, 382 Sky Scenario (Shell)  240–41 small business loans  297–301, 303 small to medium enterprises (SMEs)  393, 422, 522, 559 smart contracts  541, 555, 556, 570 smart home products  512 SMART targets  277–78 smartphones  286, 300, 511, 526, 540, 541, 545, 553, 565 social bonds  16, 355–56, 370, 372 social impact bonds  355–56 social impacts  8, 9–10, 73–77, 181, 184, 433, 448, 567 Social Loans Principles  137, 308–09, 322 social media  457, 543 social norms  82, 221–22, 559 social projects  169, 309, 356, 590 socially responsible investing  437, 491 soil  53, 59, 64, 74, 80–81, 106, 299, 307, 421 Solactive  362, 482 solar power  91, 93, 193, 359, 368, 517, 543, 555–56 solar radiation  59–61, 64 SolarArise 420 SolarCoin 555–56 Solvency II  156, 504 South Africa  132, 254, 339, 382 sovereign bonds  333, 338, 339 sovereign catastrophe risk pooling  524–26, 533 Spain  25, 78, 223, 336, 561 special purpose entity/ vehicle  314, 329, 368 species loss  55–56, 73 sponsors 314 stakeholder value approach (capitalism)  34, 47, 169–70, 277 standards  4, 65–66, 183–84, 252 see also International Sustainability Standards Board (ISSB) State Street Euro Sustainable Corporate Bond Index Fund  364 Statement on the Purpose of a Corporation  34 status quo bias (inertia)  485, 486, 579, 604 steady state (post-growth) economies  91–92, 96, 98 stewardship  183, 359, 459, 470, 488, 613, 618

Index stock exchange listings (segments)  337, 359–61 Stockholm Green FinTech (Digital Finance)  563 Stockholm Resilience Centre  54, 70 stocktakes  110, 231, 232, 233–34, 582 Storebrand 222 Storm Alex  58 Storm Ciara  58, 78 Storm Dennis  78 stranded assets (asset stranding)  85–87, 98, 215, 220, 224, 234, 263, 450, 455 stratospheric ozone  64 stress testing  130, 246–48, 256, 394, 397–98, 425 subsidies  219, 253, 331, 416, 529, 530, 554, 586, 598 Sudan 77 sukuk 358–59, 372 sulphate pollution  55, 69 supply chain management  37, 450 SURE programme  355 sustainability, defined  6–7 Sustainability Accounting Standards Board (SASB)  178, 181, 182, 186, 203 Sustainability Activity Index  274 Sustainability Alignment Scale  141 Sustainability Awareness Bond  403 sustainability bonds  16, 356–57, 361–67, 372 Sustainability-linked Bond Principles  356–57, 373 sustainability-linked bonds  356–57, 372, 387 Sustainability Linked Loan Principles  137, 311–12, 322 Sustainability-Linked Loan with Engagement Dialogue programme  413 sustainability-linked loans  309–11, 321, 323 sustainability performance targets (SPTs)  137, 312, 356, 357 Sustainable Banking and Finance Network  121, 137, 233 Sustainable Bond Grant Scheme  339 Sustainable Development Goals (SDGs)  10, 17, 37–44, 46, 48, 149, 354–55, 370, 407–09 SDG bonds  354– 55, 372 SDG-linked bonds  354–55, 372 Sustainable Development Goals (SDGs) FinTech Initiative 563 sustainable finance, defined  7–8, 10, 28, 29, 47 Sustainable Finance Disclosures Regulation (SFDR)  15, 125, 130, 441, 451, 577 Sustainable Finance Hub  118 Sustainable Finance Network  121, 233 Sustainable Finance Strategy (2021)  132 Sustainable Finance Technical Skills and Competencies Framework  132 Sustainable Finance Working Group  120 Sustainable Insurance Forum (SIF)  121, 140, 233, 500, 504

Application Paper on the Supervision of Climate-related Risks in the Insurance Sector 507 Issues Paper on Climate Risks to the Insurance Sector 501 sustainable investing  184–86, 432–34, 438–86, 491 Sustainable Shipment Letter of Credit  315–16 Sustainable Stock Exchanges Initiative  113, 141–42 Sustainalytics  197, 306, 343, 349, 357, 468, 550 Sweden  106, 273–74, 284–85, 288, 292, 336, 339, 539, 563 Swedish Central Bank  387 Swiss Cornèr Bank  285–86 Swiss Green Fintech Network  538 Swiss National Bank  387 Swiss Re  83, 214, 502, 503, 515 Switzerland  107, 239, 470, 564 syndicated loans  305, 314, 318, 322 tail risks  215 target setting  237, 238, 276, 277–78 targeted refinancing  388 Task Force on Climate-Related Financial Disclosures (TCFD)  120–21, 156, 212, 215, 232, 236–48, 261, 576 Task Force on Climate-related Financial Risks 121, 156, 212 Task Force on Digital Financing of the SDGs (UNDP)  118, 557–60 Taskforce on Nature-related Financial Disclosures (TNFD)  212, 248–49, 250, 263, 599–600 Taskforce on Scaling Voluntary Carbon Markets 259, 263 taxation 184, 185, 219 carbon  133, 254, 259, 587 carbon border  256, 262 taxonomies  132, 144, 184, 342, 538, 586, 589 EU  14–15, 26, 125, 126–29, 192, 193, 252, 333, 345 technical assistance  421 technical screening criteria  127 technology  8, 15, 40, 85, 91, 217, 220–21, 455, 519–20 mobile  92, 281, 286–88, 299, 527, 537–38, 543, 545, 553–54 satellite  62, 196, 198, 287, 511, 527, 541, 548, 553–54, 590 sensor  196, 198, 511, 512, 590 see also AI (artificial intelligence); apps; automation; blockchain; CleanTech (GreenTech); cloud computing; smartphones temperature rises  54, 55, 57, 63, 69–70 Temperature Score  551

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Index Terna 314 Tesco 310 Tesla  318, 455 thematic investment strategies  446, 447, 474 thermals  60, 61 tilt investment strategies  14, 387 topic standards  184 trade finance  314–16, 323 trade winds  61 tragedy of the horizon  32, 48, 384–85, 484 training  9, 148, 150–53, 212 transition bonds  350, 357–58, 361, 370, 373 transition finance  13, 14, 48 Transition Pathway Initiative  361, 463 transition ratio (SEB)  274 transition risks  83, 85, 190, 211–12, 216–23, 260, 263, 500 transparency  4, 244, 277–78, 332, 342, 541, 566, 614 transverse (cross-cutting) risks  84, 151, 208, 209, 212, 213, 226, 227, 595 travel insurance  513–14 Trine 543 Triodos Bank  23, 24–25 triple bottom line  24–25 tropospheric ozone  81 Tumelo 468–69 ‘2 and 20’ private equity  475 2 Degrees (°) Investing Initiative  66, 189 UBank 291 Ukraine war  255, 461 underwriting  318, 319, 335 UNFCCC Framework Convention on Climate Change  11, 19, 48, 79, 106, 109 Standing Committee on Finance  16, 105, 193–94, 203 see also COP (Conference of the Parties); Green Climate Fund; nationally determined contributions (NDCs); Paris Agreement; Race to Zero unit trusts (open-ended funds)  464, 466, 491 United Kingdom (UK)  14, 17, 55, 106–07, 111–12, 119–20, 197, 223, 238 Build Back Better campaign  89–90 Climate Change Committee  291 Climate Financial Risk Forum  251 Dasgupte Review (2021)  248, 595, 596 ETS scheme  255 flood defence spending  78 GHG emissions  80, 291 green bonds  336, 339 Greening Finance Roadmap  124 ISAs 290–91 regulation  251, 252, 451–52 Stern review (2006)  82–83

see also Bank of England; Financial Conduct Authority; Green Finance Education Charter; Green Finance Institute; Green Investment Group (Bank); Green New Deal; NatWest; Prudential Regulation Authority United Nations (UN)  107, 113, 540 see also Convention on Biological Diversity; Intergovernmental Panel on Climate Change (IPCC); Sustainable Development Goals (SDGs); UNFCCC Framework Convention on Climate Change United Nations Development Programme (UNDP)  118, 249, 557–60 SDG Impact Standards for Bonds  354–55, 370 Task Force on Digital Financing of the SDGs  118, 557–60 see also Sustainable Finance Hub United Nations Environment Programme (UNEP)  10, 67, 88, 166, 557 ‘State of Finance for Nature’ (2021)  595, 596 United Nations Environment Programme Finance Initiative (UNEP FI)  94, 113–18, 157, 233, 237, 241, 249, 277–80, 449, 605–07 see also Net Zero Asset Owner Alliance; Net Zero Banking Alliance; Net Zero Insurance Alliance; Principles for Responsible Banking; Principles for Responsible Investment (PRI); Principles for Sustainable Insurance; Sustainable Stock Exchanges Initiative United Nations Global Compact  113, 141, 188, 551 United States (US)  58–59, 83, 107, 109, 110, 119, 133, 222, 223 Biden Administration  133, 218, 251, 340 Business Roundtable  34 credit unions  282 ETS schemes  255 green bonds  336, 340 insurance  501–02, 505 investment strategies  451, 461 mortgages 567 Paris Agreement  218, 577 regulation  251, 252 see also Federal Reserve; Financial Stability Climate Committee; Securities and Exchange Commission universal standards  183 University of Cambridge Institute for Sustainability Leadership  141, 184, 275, 315–16, 393, 450, 502–03 usage-based insurance  510–11, 533 use of proceeds (organization-guaranteed) bonds  329, 333–34, 352, 372, 373

Index Vacuumlabs 539 values 613–19 values-based investing  433, 491 VanEck Vectors Green Bond ETF  365 Vanguard  445, 467 vanilla bonds  332, 333, 338, 350, 351 Vanuatu 525 venture capital  28, 274, 476–78, 491, 537 verification  172, 173–74, 196, 203, 312 Verified Carbon Standard (Verra)  258 vertical integration  93 very dark (deep) green strategies (shareholder activism)  442–46, 459, 491 very light green strategies (negative screening)  433, 434, 437, 438–39, 490 Vigeo Eiris  314, 343 Volkswagen diesel emissions-testing scandal  145, 222 voluntary carbon market  257, 258–59, 263 Voluntary Carbon Markets Integrity Initiative  254, 258 voluntary carbon offsets  257, 258

Wesfarmers 310 Westpac 317–18 WHEB Sustainability Fund  482 window guidance  388 Winners and Spinners report (Castlefield) 481–83 World Bank  91, 255, 273, 352, 405, 590 Climate Investment Funds  412–13 see also International Finance Corporation World Bank Group  405–06 World Business Council for Sustainable Development 65–66 World Economic Forum (WEF)  209, 248, 249, 595–96 World Meteorological Organization (WMO)  67, 111, 501 World Resources Institute  65, 188 World Wide Fund for Nature (WWF)  56, 188, 249, 289, 561, 595, 605 World Wide Generation G17 Eco Platform 552 XL Catlin  519

waste management  26, 27, 35, 92, 185 water conservation  27, 38, 53, 74–76, 91, 93, 126, 175, 180, 185 weather 57 wellbeing  38, 185 Wellington Management Company LLP  467

YES BANK  289–90 younger employees  151 zero carbon  106, 157

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