Across the globe, physical climate impacts have become more pronounced and damaging in recent years, with grave implications for many vulnerable people and societies. The four-year period between 2015 and 2018 has been confirmed as the hottest on record and was replete with extreme weather triggered or exacerbated by climate change that negatively affected, and sometimes devastated, many countries and millions of people and their livelihoods, rippling out to entire ecosystems and economies.
Both acute and chronic impacts from a changing climate are already manifesting in financial and economic losses around the globe, not only in emerging economies of the global South but also in more developed economies in Europe, Asia, and North America, potentially inflicting over US$69 trillion in damages by the end of the century. Warming that has already been locked in by historical emissions necessitates enormous levels of financing to deliver resilience across all countries, regions and markets. This shift can only happen with the concerted action of two key constituents: Financial Governance Bodies, including policymakers, regulators, and supervisory bodies; and Financial Actors, including investors of all types, and financial institutions and banks.
A new report authored by Climate Finance Advisors and titled “Driving Today’s Financial System for the Resilient Climate of Tomorrow” on behalf of UNEP-FI served as a background paper for the Global Commission on Adaptation (GCA). This paper, released yesterday, describes areas where these two important sets of constituents must focus efforts in order to adjust, align, and accelerate the transformation of the financial system to support resilience to the impacts of climate change. More specifically, the report explores approaches for promoting systemic change in the economic and financial system to embed risk and resilience in financial decision-making at the policy and institution level.
Importantly, financial policymakers and governance bodies play an ever-important role in ensuring that an ecosystem of finance exists that drives resilience, including through the full integration of climate-related financial risks into the mechanics of the financial system, and the acceleration of the low-carbon transition. Through a combination of policies, standards, metrics, measurements, and the tools to undertake proper risk management, the ecosystem of financial actors supported by clear-eyed financial policies can build the enabling environment that can drive and finance our resilience.
Addressing climate risk will be important for both policymakers and institutions and is a necessary condition for ensuring the financial system supports climate resilience (and is itself resilient in the face of impacts from climate change). Financial actors of all types evaluate and manage risks of all kinds as the basis of making investment decisions. These institutions have built-in skillsets needed to incorporate climate-related elements into risk assessment practices to better assess, quantify, and price climate-related financial risks. To date, few in the financial sector are incorporating the financial consequences on returns from physical climate risks – both acute and chronic – into investment decision making.
“Driving Today’s Financial System for the Resilient Climate of Tomorrow” is part of a series of roughly 30 background papers commissioned by the GCA to inform its forthcoming 2019 flagship report, which is designed to spur the global community into action on adaptation and resilience to climate change. The paper benefitted from input from more than a dozen thought leaders and organizations active on many issues related to adaptation and finance. Its specific recommendations include:
- Accelerate and Promote Climate-Relevant Financial Policy, Regulation: Financial System Governance Bodies can each play a key role in ensuring climate considerations – including those risks posed by physical impacts from climate change – are consistently disclosed and addressed in policies, regulations and enabling measures that guide Financial Actors across the financial system.
- Develop, Adopt, and Employ Climate Risk Management Practices: Promoting and incentivizing the development and wide-scale application of climate risk management practices and tools, including robust scenario analysis, is essential for all Financial System Constituents. Understanding and internalizing climate risk into financial decision-making is essential for both (i) reducing exposure to investments from climate change, and (ii) identifying opportunities to invest in resilience align the financial system towards climate-resilient investments.
- Develop and Adopt Adaptation Metrics and Standards: It is vital to accelerate ongoing efforts to establish a set of common definitions, metrics, and standards to help the financial sector identify what constitutes an “adaptation investment” or an “investment in resilience/which is climate-resilient,” as well as more complex systems for hazard classification, ratings, and scoring.
- Build Capacity Among All Financial Actors: Addressing climate risk and pursuing investment opportunities in resilience requires building capacity and skillsets, particularly to bridge the understanding of the physical sciences with knowledge of credit and risk management and financial valuation.
- Highlight and Promote Adaptation and Resilient Investment Opportunities: Addressing the adaptation needs that result from this warming and aligning those with the 2015 Paris Agreement is perhaps the biggest investment opportunity of this generation. Adjusting and aligning the financial system to this challenge has the potential to truly “unlock” the necessary capital – both private and public – that can support investment in adaptation and resilience.
- Use Public Institutions to Accelerate Adaptation Investment: Through policy, blended finance and other mechanisms, governments and public financial institutions have the potential to play an outsized role in accelerating, catalyzing and directing investments in critically important areas, such as the low-carbon, climate-resilient transition. Supporting or creating financial institutions with mandates which incentivize climate-resilient investment, particularly to benefit vulnerable communities and countries could significantly help to accelerate needed adaptation and resilient investments.
Fundamentally, transforming the financial sector into an engine for resilience requires adjusting our risk management practices to assess, quantify, and manage climate-related financial risks, and in turn bring to the surface the vast amount of investment opportunity that results from addressing adaptation and resilience. It also requires establishing the definitions, metrics and standards around adaptation and resilience, as well as transparent disclosure of climate-related financial risks, which can enable the financial system to align investments with goals of the Paris Agreement. And finally, it requires orientation of public policy, blended finance approaches, and other mechanisms to fuel the acceleration of climate-resilient investments (and accelerating investment in resilience).
Climate Finance Advisors and Alan Miller presented an overview of the paper during a webinar hosted by UNEP-FI on July 17, 2019. A recording of the webinar can be found here.