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Climate finance, risk, ESG and a shift to green finance

© Shutterstock / PeachShutterStockSustainable finance.

In a week that saw the world hits its highest temperatures to date, it’s a major concern to see news that the UK is set to cut its £11.6 billion climate and nature funding pledge. This week’s roundup looks at how climate risk is underestimated, how insurance needs to address underwriting, growing scrutiny for ESG ratings and a shift to green debt.

The UK might have positioned itself as a leader on climate action, but cuttings it’s climate finance commitments would undercut the country’s international reputation, as well as momentum for the upcoming COP28 climate negotiations. While the Foreign Office said the UK was still committed to the pledge, it will be interesting to see what that ends up looking like.

Climate risk is being underestimated

The news of the potential loss of climate funds comes as concern about climate risk increases. Not only has the global record for the hottest day been broken days in a row, but a report from  the Institute and Faculty of Actuaries (IFoA) and the University of Exeter has found that economic economic models underpinning climate scenario modelling in financial services do not always reflect the threat climate change poses – to the extent that the authors warn that the financial services sector must act urgently to embed the impact into risk management.

The report warns that ‘some current scenarios could have limited use as they do not adequately communicate the level of risk we are likely to face if we fail to decarbonise quickly enough.’

Techniques being used now exclude many of the most severe impacts of climate change such as sea-level rise, heat stress or climate tipping points, where a change in the climate system becomes self-perpetuating such as the loss of Arctic sea ice or the Greenland ice sheet.

They also exclude second order impacts for human society such as civil unrest and involuntary mass migration which could cause significant economic impacts. The report lays out how the results emerging from current models are far too benign and, in some cases, implausible, using actuarial techniques to examine the limitations and assumptions of models used.

Given how important scenarios are for everything from climate modelling, to central bank planning to stress testing the economy, this is a serious concern.

Focus on the importance of insurance

The politicisation of climate action is a particular concern in financial services for insurance, as many projects that are not zero-aligned would never off the ground without insurance. Pressure in the US on anti-trust grounds has seen an exodus of members from the Net Zero Insurers Alliance (NZIA), despite former members continuing to use its methodologies. Even worse, it has dropped its requirement for members to set and publish targets for underwriting.

The Insure Our Future campaign issued a statement that the NZIA’s target setting protocol doesn’t violate any anti-trust laws and that the attacks of the US fossil fuel lobby on the Alliance have no legal merit. Peter Bosshard, coordinator of the Insure Our Future campaign said: ““It is unfortunate that UNEP caves to the fossil fuel lobby and abolishes the last material requirement which NZIA members have to fulfill. This reduces the Alliance to an empty shell and opens the door for further net zero greenwashing by the insurance industry.”

That means there is now is no standardised methodology or requirement for tracking financed emissions from underwriting – it’s not even in the SBTI consultation. That needs to change in a hurry, but apparently the Financial Institutions Net-Zero Standard draft consultation is setting the groundwork for this work.

This is a particularly important point considering the refocus of the oil and gas industry on new exploration. Despite the recognition that there is no room for new oil and gas under a 2050 net zero scenario, the industry seems to be doubling down – in the UK the government has allowed a new coal mine and offshore licencing.

In a recent comment Shell (LSE: SHEL) chief executive Wael Sawan said that cutting back on cutting fossil fuels would be ‘dangerous and irresponsible’. Yet extreme weather events are already having massive impacts from floods in Pakistan, wildfires across Canada and cyclones in South Asia.

Charlie Kronick, Senior Climate Advisor at Greenpeace UK, said: Shell is gaslighting consumers while cashing in on energy price rises, increasing shareholder dividends and slashing investment in renewable energy, which can provide cheap, clean power across the world. Fossil fuel greed is endangering us all; we need urgent global action to force Shell and the wider oil industry to stop drilling and start paying for the damage they are causing to our planet and those who live on it.”

 There’s no doubt that these are fighting words – but the oil industry is going to need to address climate concerns if their licence to operate is to continue.

While opinions may differ, one of the most fundamental differences is whether one’s focus is on short term financial return or long term return. There are going to be challenges in the net zero transition in economic, employment and operational terms, but it seems that it would be more sensible to address them rather than pretend that they can be ignored.

Reporting and ratings

The UK’s Financial Conduct Authority (FCA) has welcomed the launch of a consultation on a  voluntary code of conduct for environmental, social, and governance (ESG) data and ratings providers saying “As firms grow increasingly reliant on third party ESG data and ratings products, we support this industry-led solution to increase transparency and trust in this growing market.”

In 2022, the FCA appointed the International Capital Market Association and the International Regulatory Strategy Group to convene an industry group to develop a voluntary code. The Group is co-chaired by M&G  (MNG.L), Moody’s  (MCO.N), London Stock Exchange Group (LSEG.L) and Slaughter and May, with the FCA, HM Treasury (HMT) and other relevant financial regulators acting as observers.  As part of the Code’s development, the group engaged with standard-setters in other jurisdictions to ensure international consistency – in particular recommendations from global securities watchdog IOSCO. It will cover governance at ratings agencies, systems and controls to ensure high-quality ratings, managing conflicts of interest and transparency over methodologies.

The UK is now consulting on a voluntary code, and the Monetary Authority of Singapore recently proposed its own code of conduct for ESG ratings providers and products. However the EU has  proposed a draft law as part of its sustainable finance proposals, to increase scrutiny of, and transparency for, ratings agencies in June 2023. The idea is to avoid greenwash and for many in the market, voluntary codes of conduct are a precursor to regulations to ensure a level playing field for all.

The Code consultation will run for 3 months, until 5 October 2023. The Code will be updated and finalised by the end of 2023. So if you want to have your say, jump to it.

Sustainable investment

Its important to remember that sustainability is about more than CO2 emissions. Franklin Templeton has launched two new thematic ETFs to invest in companies involved in sustainable practices across the healthcare (Goal 3: Health and Well-Being) and food (Goal 2: Zero Hunger) network. According to Dina Tina, head of global index portfolio management: “By 2050, the global population will have increased by two billion to almost 10 billion, meaning that food production will need to increase by around 60%. The wellness market is also projected to grow from $4.4 trillion in 2020, or 5% of global economic output, to $6.8 trillion by 2030.”

In Japan, Mizuho (T:8411) has raised its sustainable finance goal to $700 billion by 2030 and issued the largest ESG bond to date by Japanese financial institutions. The company says that it issues and manages “green bonds based on a green bond framework we renewed in February 2023, which is in line with the International Capital Market Association’s Green Bond Principles 2021. The framework has obtained a second-party opinion from Sustainalytics, a third-party certification organization.”

In Italy, Aeroporti de Roma has issued a €400 bond tied to its climate goals while Heathrow also raised a €650m sustainability linked bond. Meanwhile in Spain Iberdrola raised a further €850 million in green finance, part of its €47 billion planned investment in renewables between 2023-2025.

Interesting to note that Iberdrola(MADRID: IBE)’s bond demand hit over €2 billion considered that Bloomberg has released some data showing that nearly $350 billion was raised in green debt in H1 of 2023, against $235 billion for oil, gas and coal-related finance. That certainly brings into question Shell’s read on the direction of travel from the financial sector. Obviously the lack of transparency about use of funds and how exactly ‘green’ is being defined means its not yet clear if this signals a market shift – but it certainly looks like one.

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