Governments and regulators in emerging markets and developing economies need to constantly learn from the best global practices and adapt them to their respective jurisdictions.
Countries across the globe need substantial additional financial resources, much beyond the requirement under the business-as-usual scenario, to timely meet the greenhouse gas (GHG) mitigation commitments, climate adaptation needs, and Sustainable Development Goals (SDGs).
The recently held G20 summit in New Delhi, in September 2023, noted that developing countries require US$5.8-5.9 trillion in the pre-2030 period to implement their nationally determined contributions (NDCs). The Summit also noted that US$4 trillion per year is required by 2030 for clean energy technologies to reach net zero emissions by 2050.
The International Monetary Fund’s (IMF) Global Financial Stability Report of October 2023 projects that the growth in public investment, for achieving the transition to net-zero emissions by 2050, will be limited. The private sector will, therefore, need to make a major contribution towards the large climate investment needs of emerging markets and developing economies (EMDEs), which currently emit around two-thirds of GHGs. It estimates that to meet the target of net zero by 2050, the share of the private sector in these economies will need to increase to about 90 percent (excluding China) of the required investment by 2030, from the existing level of about 40 percent.
The private sector will, therefore, need to make a major contribution towards the large climate investment needs of emerging market and developing economies (EMDEs), which currently emit around two-thirds of GHGs.
EMDEs have twin difficult tasks that are cut out for them—to facilitate humongous private sector investments in climate financing; and to ensure that their economies go through the green transition systematically, without red-flagging financial stability concerns. There are additional challenges. On account of limited resources and a lack of domestic institutional investors committed to climate financing and under-developed financial markets, EMDEs would need to depend a lot upon foreign investments to meet a sizeable portion of the projected private capital requirement.
EMDEs have low international credit ratings, with many developing countries lacking even investment-grade credit ratings. In the absence of a clear taxonomy regime, the so-called ‘green projects’ in EMDEs may not meet the norms for such projects in developed countries. Then, investors face the currency risk, which is further exacerbated by the current adverse global geopolitical scenario.
EMDEs have low international credit ratings, with many developing countries lacking even the investment-grade credit ratings.
Governments and financial sector regulators across the world need to plan, be vigilant, and develop capabilities to ensure an orderly green transition of their economies. Their roles could, perhaps, be broadly divided into two categories, viz. ‘ensuring correct green labelling and facilitating investments’ and ‘ensuring financial stability’.
This essay touches upon the global scenario as well as the Indian position in these two areas.
Accurate and objective disclosure, by corporates, of their climate-related financial risks is crucial for the pricing and management of such risks, not only by the corporates themselves but also by investors, lenders and others with financial exposures to those companies.
Such disclosures are particularly relevant from the point of view of investors—to save them from mis-selling by the issuers through greenwashing. That said, ensuring correct green labelling is a challenging task in the absence of a universally recognised ‘green taxonomy’, disclosure standards, and reporting frameworks.
A number of different disclosure standards like Global Reporting Initiatives (GRIs), Task Force on Climate-Related Financial Disclosure (TCFD) and Sustainability Accounting Standards Board (SASB) are being followed in various jurisdictions. Also, the taxonomies vary from place to place. Much work has been ongoing in many international bodies with the goal of developing globally consistent and comparable public disclosures by firms of their climate-related financial risks. Equally important is to facilitate interoperability between the international standards and the jurisdiction-specific requirements.
Much work has been ongoing in many international bodies with the goal of developing globally consistent and comparable public disclosures by firms of their climate-related financial risks.
After intensive deliberations for over two years, the International Sustainability Standards Board (ISSB), in June 2023, came out with standards to serve as a global framework—IFRS S1 on general sustainability-related disclosures and IFRS S2 on climate-related disclosures. Now, the International Organization of Securities Commissions (IOSCO) needs to work out the modalities of implementing these standards across the globe.
Coming to the Indian position, the Securities and Exchange Board of India (SEBI), in 2021, came out with the Business Responsibility & Sustainability Report (BRSR) framework, and made this reporting mandatory for the top 1,000 listed companies by market cap from 2022-23 onwards. India was one of the pioneers amongst large economies to mandate this to its corporates.
BRSR is a broad concept encompassing various environmental, social and governance (ESG) attributes while prescribing detailed reporting formats. The framework provides for the interoperability of the BRSR reporting framework with prevalent international frameworks. SEBI envisages verification of the filed BRSR claims through third-party assurance providers. This should be operationalised quickly. SEBI, in consultation with industry and other stakeholders, may also examine the extent to which the IFRS S1 and IFRS S2 standards are suitable for adoption in the Indian scenario. SEBI has also recently come out with a policy on ESG disclosures by funds and their ratings, and a framework for regulating ESG rating providers. In addition, the regulator has guidelines for mutual funds issuing ESG-themed schemes.
SEBI, in consultation with industry and other stakeholders, may also examine the extent to which the IFRS S1 and IFRS S2 standards are suitable for adoption in the Indian scenario.
India addressing the following concerns is the need of the hour:
Both these steps are important for investors, especially foreign and domestic institutional investors.
There is a growing global focus on potential risks to financial stability from climate change. An unplanned and disruptive transition to a low-carbon economy could have destabilising effects on the financial system.
Ensuring financial resilience is a prerequisite for raising significant, substantial, and additional resources to meet climate financing. In fact, addressing financial risks from climate change and mobilising sustainable finance are interrelated and credible actions on both fronts would be mutually reinforcing.
An unplanned and disruptive transition to a low-carbon economy could have destabilising effects on the financial system.
A large number of international bodies—including the Financial Stability Board (FSB), Basel Committee on Banking Supervision (BCBS), The Committee on Payments and Market Infrastructures (CPMI), International Association of Insurance Supervisors (IAIS), The International Organization of Securities Commissions (IOSCO), International Financial Reporting Standards (IFRS), The Organization for Economic Cooperation and Development (OECD), IMF and World Bank—have been working on how to address climate-related financial risks. Their work is also regularly reviewed at G20 meetings.
The FSB, with its diverse membership—including financial authorities from individual jurisdictions (ministries of finance, central banks, banking and insurance supervisors, securities market regulators), standard-setting bodies, and international organisations—makes it well placed to coordinate this work.
In July 2021, FSB came up with a roadmap as a comprehensive and coordinated plan for addressing climate-related financial risks, including steps and indicative timeframes needed to do so. The roadmap covers four interrelated areas, namely, firm-level disclosures, as the basis for the pricing and management of climate-related financial risks; data, for the diagnosis of climate-related vulnerabilities; vulnerabilities analysis, for designing and applying the regulatory and supervisory frameworks and tools; and regulatory and supervisory practices and tools to address the climate-related risks to financial stability. FSB presented a summary of the progress made so far in these four areas, as well as the way forward, in the recently held G20 meeting in September 2023.
The climate-related financial vulnerabilities and potential financial stability impacts require a systematic assessment. The analytical tools to assess such vulnerabilities and scenario analysis need to be further developed and refined. Climate risks should be embedded into standard vulnerability assessment frameworks. The need for having a robust and reliable data source is imminent.
The climate-related financial vulnerabilities and potential financial stability impacts require a systematic assessment.
The FSB notes that the regulatory and supervisory capabilities and tools have to be in place to address climate-related risks, both within individual sectors and at the system-wide level. Supervisory and regulatory approaches to climate-related risks should be integrated within the overall supervisory and regulatory approaches to address financial risks. Both the micro-prudential and macro-prudential perspectives have to be kept in mind. The FSB envisages the sharing of good practices among different countries to assist comparability, taking into account sectoral and jurisdictional specificities.
As for the Indian position, the financial sector intermediaries in India need to quickly develop the capabilities to understand and assess climate-related vulnerabilities, and to take them into account in their overall vulnerabilities assessment frameworks. For instance, the banks’ capital adequacy framework should acknowledge and provide for climate-related risks. Their lending to projects vulnerable to climate change impacts has to be assigned relatively higher risk weightage while computing the banks’ overall capital adequacy requirement.
In July 2022, the Reserve Bank of India (RBI) published a discussion paper on ‘Climate Risk and Sustainable Finance’ intending to firm up guidelines on its regulated entities on the subject. The paper borrows from the global best practices suggests guidance to regulated entities on risk management structure and explores how tools like stress testing and climate scenario analysis can be used to identify and assess vulnerabilities. RBI is yet to issue the guidelines, which should be expedited.
The insurance companies, while fixing premium amounts, have to carefully consider the possible impact of climate change on their clients or clients’ assets.
Similar discussion papers should be issued by SEBI and the Insurance Regulatory and Development Authority of India (IRDAI) for their regulated entities. While much would be in common with the RBI discussion paper, there would be some sector-specific issues relating to risk assessment, scenario analysis, and stress testing. For instance, insurance companies, while fixing premium amounts, have to carefully consider the possible impact of climate change on their clients or clients’ assets. Similarly, asset managers have to make appropriate pricing adjustments in the assets likely to be impacted by climate change.
All the financial sector intermediaries should make climate-related vulnerability information and data regularly available to their respective regulators for close monitoring. Inter-regulatory coordination is important to strategically plan for addressing climate-related macro-financial risks. The Financial Stability and Development Council (FSDC), chaired by the Finance Minister, would be the right forum for such coordination.
In conclusion, climate change and sustainable financing issues are ever-evolving, with many global developments taking place at a rapid pace. The whole ecosystem is at a nascent stage in most of the EMDEs. The governments and the regulators there face a steep learning curve. They need to constantly learn from the best global practices and adopt them while taking into account their respective jurisdictional considerations.
Ajay Tyagi is a distinguished fellow at ORF and former chairman of SEBI.
The views expressed above belong to the author(s). ORF research and analyses now available on Telegram! Click here to access our curated content — blogs, longforms and interviews.
Ajay Tyagi specialises in the financial sector especially the capital markets. He has also worked extensively in the environment and energy sectors. He served as the ...
Read More +
PREV
