This piece is part of the essay series, Shaping our green future: Pathways and Policies for a Net-Zero Transformation.
Introduction
The UN Intergovernmental Panel on Climate Change (IPCC) estimates that an annual investment of US $2.4 trillion is needed in the energy sector alone until 2035 to limit temperature rise to below 1.5 °C from pre-industrial levels.<1> Indeed, climate finance takes centre-stage in every world climate meeting under the aegis of the United Nations Framework Convention on Climate Change (UNFCCC). Developed countries committed to channel US $100 billion in climate finance annually by 2020 to developing countries. The commitment for US $100 billion was first announced in Copenhagen Accord in 2009, formalised in the Cancun Agreements of 2010, and reaffirmed by the Paris Agreement in 2015.<2>
Climate finance can come from a range of sources: Bilateral concessional lending, multilateral concessional lending, development finance institutions, and private institutions. What constitutes climate finance, how much has been committed, and where it has been used remain subjects of intense debate. OECD claims that developed countries have committed a total of US $79.6 billion in 2019 (last available figure). These numbers, however, are being challenged by many developing countries, including India. They argue that climate finance to the developing world is being embellished by unfairly counting pledges instead of actual flows, therefore, overrepresenting ‘new and additional’ funds and underrepresenting greenwashing allocations, and unnecessarily including non-concessional loans.<3> This was corroborated by an ORF study that found India raised 85 percent of the US $21 billion for climate finance in 2018 domestically, and that 60 percent of the US $291 billion of outflow in climate commitments from OECD, was re-invested in OECD countries.
Climate finance to the developing world is being embellished by unfairly counting pledges instead of actual flows, therefore, overrepresenting ‘new and additional’ funds and underrepresenting greenwashing allocations, and unnecessarily including non-concessional loans.
Developing countries must engage in robust dialogue with global stakeholders on how climate finance is mobilised, reported, and leveraged. This article examines the policy and regulatory architectures for global climate finance that preclude multilateral, bilateral, and private capital from committing climate finance to developing countries such as India.
1. Multilateral Development Banks: The Risk Management Imperative
Multilateral Development Banks (MDBs) can provide the necessary catalytic financing for climate adaptation and mitigation. By now, there is agreement that the MDBs must be re-oriented, reconfigured, and recapitalised to enable greater climate finance for developing countries. Are they geared up for such a mission? The US $2 trillion in total assets held by MDBs is modest compared to the US $100 trillion in assets under management by the world’s largest 500 asset managers and institutional investors.<4>
To enhance the role of MDBs, they can be re-oriented from concessional lending towards facilitating private capital by acting as underwriters. Guarantees allow the “crowding in” of large-scale private commercial capital by providing the necessary hedge for investors and lenders concerned about political and financial risks associated with emerging economies.<5> So far, guarantees have accounted for 45 percent of the total private finance raised by MDBs.<6> Therefore, there is considerable scope for the instrument to be leveraged further.
The G20 2018 Eminent Persons Group report on Global Financial Governance made similar suggestions for scaling the work of the MDBs for mobilising private finance, expanding private reinsurance markets, and building an infrastructure asset class to draw investors.<7> Therefore, there is an opportunity for MDBs to fulfil their vital role and act as a bridge between private investors and recipient economies and move away from lending to risk mitigation. They can also serve as intermediaries between the real pools of capital and the most productive destinations for those savings.
An alternative suggestion has come from the Bank of Italy, which suggests that MDBs could triple their spare lending capacity if the institutions decide to reduce their rating to AA+.
Another suggestion worth examining is to re-evaluate the capital requirements and corporate governance guidelines for MDBs. Conceptually, MDBs are assessed by credit-rating agencies in the same way as commercial banks. This imposes unnecessary restrictions on lending when MDBs clearly differ from commercial banks on “preferred creditor treatment”, “callable capital”, and “concentration risk”.<8> A 2016 study by S&P concluded that MDBs could “safely lend more” even without threatening their AAA ratings – a step that may enable another trillion dollars in lending. An alternative suggestion has come from the Bank of Italy, which suggests that MDBs could triple their spare lending capacity if the institutions decide to reduce their rating to AA+.
Yet, MDBs remain conservative in their risk assessments. One parameter on which MDBs and S&P differ is the treatment of “callable capital” when calculating risk. Callable capital are the commitments made by the members of the MDBs beyond shareholder equity to support the MDBs in case of crises. As a paper from Overseas Development Institute (ODI) explains, rating agencies include callable capital in their rating assessments of MDBs whereas the MDBs themselves do not do so in their internal models. MDBs face pressure from major shareholders who are reluctant to indicate even the remote possibility that callable capital can be activated. A related study conducted by G24 in 2015 found that MDBs can even be negatively assessed in the event of a decline in the sovereign ratings of their shareholder countries providing the callable capital.<9> Therefore, MDBs remain averse to the idea of tying their assessments to callable capital–a situation that can be changed with political consensus amongst the members.
2. International Financial Regulations: The Reporting Imperative
The 2008 financial crisis compelled banking supervisory authorities such as Basel, to set certain macro-prudential policies and international regulatory standards. Although these regulations are mostly developed by, and calibrated for developed countries, many emerging markets and developing economies have gradually adopted these standards.
The direct impact of Basel norms on climate finance to developing nations (or India in particular) is difficult to determine. On one hand, the norms provide a uniform global framework for macro-prudential governance which are welcome for many developing nations, including India. On the other hand, research indicates that specific regulations may have unintended side effects on long-term finance. This, by extrapolation, may also affect climate finance.
For instance, a study by the French Development Agency in 2020 found that Basel 3 standards designed for commercial banks were less relevant for national development banks, which have different structural and risk characteristics. Specifically, levels of capital requirement and the demand for capital quality which may restrain NDBs from providing credit to long-term projects, particularly during times of economic distress. Similarly, liquidity ratios such as the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR), designed to promote financial resilience and avoid maturity mismatches, respectively, need to be re-examined for NDBs whose sources of funding rely on non-household deposits.<10> This suggests that there is a need to review the Basel framework to account for climate-related risks given the dire need for long-term climate finance.
More recently, the UN, G20, global standard-setting bodies on international finance, and independent initiatives as well, have been working on reporting and disclosure regulations for climate finance.
The G20’s work on climate finance is guided by the Sustainable Finance Working Group–a 2021 upgrade of the Sustainable Finance Study Group established in 2018 and the Green Finance Study Group set up in 2016. The agenda of the working group itself is telling of the magnitude of the effort at hand on streamlining regulations for climate finance. The challenges include designing tools for aligning investments towards sustainable goals, addressing disparity in disclosure norms, developing taxonomies and rating methodologies, mainstreaming priorities of nature such as biodiversity, addressing data gaps, and providing a roadmap to international financial institutions for a low-carbon pathway.
The G20 Framework Working Group in 2021 included, for the first time, macroeconomic risks connected to climate change as part of the agenda.
The FSB-led TCFD, established at the request of the G20 to focus on climate-related financial risk disclosures in mainstream corporate filings, has become the most widely referenced work in this field. According to the last status report published in September 2020, TCFD had support from over 1,500 organisations globally, including over 1,340 companies that account for a market capitalisation of US $12.6 trillion, and institutional investors responsible for assets of nearly US $150 trillion.<11>
The FSB-led TCFD, established at the request of the G20 to focus on climate-related financial risk disclosures in mainstream corporate filings, has become the most widely referenced work in this field.
FSB’s homework shows that large companies were better at disclosures than smaller ones, and that the energy sector is better than the banking industry. For instance, 42 percent of the companies with a market capitalisation above US $10 billion disclosed information aligned with the TCFD in 2019, while the average was lower at 15 percent for companies with a market capitalisation of less than US $2.8 billion.<12> Similarly, a review of 289 banks with a median asset size of US $54 billion revealed that only 20 to 30 percent of the banks were meeting TCFD guidelines–a disappointing figure especially since 40 to 60 percent of energy firms are readily disclosing as per TCFD guidelines.
Another area in which TCFD reports low coverage is disclosure on specific metrics on carbon emissions. This is likely due to the unavailability of quality data. The Network for Greening the Financial System (NGFS) has done extensive work in the use cases, metrics and data required by banks, insurers, asset managers, central banks, credit institutions, and pension funds. Their assessments conclude that carbon data available, on which much of green finance is based, is at best incomplete, or subjectively estimated.<13>
The disparities in disclosure guidelines and subjectivity in reporting is making climate finance reporting information incomplete, inconsistent, and incomparable. As investors, lenders, and insurers rely on data to make informed decisions on capital allocation and risk underwriting, standardising the disclosure and reporting frameworks across jurisdictions will be critical for developing countries to enhance their credibility and bargaining power in the global financial system.
India accounted for 0.05 percent of the global assets in sustainable funds that totalled nearly US $1.23 trillion in 2020.<14> Green bonds accounted for only 0.7 percent of the nearly US $8 billion total bonds issued in India during 2018 and 2019—a small proportion compared to the US $196 billion, US $63 billion, and US $35 billion issued in the same period, respectively, by the European Union, China, and the US. Similarly, green lending accounted for a mere 0.5 percent of the US $5.4 billion of outstanding bank lending in India as of March 2020.<15>
The Reserve Bank of India (RBI) has confirmed that the key reason for the slow uptake of green finance in India is the lack of a standardised global taxonomy and standardised global reporting. RBI has noted that “information asymmetry” is the primary cause of the high cost of bond issuance. In May 2021, the Securities and Exchange Board of India (SEBI) issued its sustainability disclosure, the Business Responsibility and Sustainability Reporting (BSBR), which includes TCFD guidelines, mandatory for FY 2022 for the top 1000 companies in India by market capitalisation. This covers a higher number of companies, up from requiring only the top 100 when it was first introduced in 2012 for BSE and NSE.
Therefore, for India, any effort, whether by the UN or G20, such as the TCFD, will be welcomed if it provides a common taxonomy and reporting standard for the world. Such a taxonomy must be reflective of developing country characteristics, includes both past and forward-looking disclosures, and is, at least in the initial years, voluntary.
3. Institutional Investors: The Returns Imperative
The average annual investment in the renewable energy sector in India has been nearly US $ 11 billion for the last five years. For now, several global institutional investors are operating or interested in India, including Singapore-based GIC Holdings, Abu Dhabi Investment Authority, Softbank, Brookfield, CPPIB and CPDQ from Canada, ORIX (Japan), Sembcorp and APG (Holland), Goldman Sachs, JP Morgan, and Morgan Stanley.<16>
Institutional investors are crucial in the fight against climate change. According to data compiled by Willis Towers Watson, institutional investors held over US $100 trillion in Assets Under Management (AUM) in 2019. Therefore, how these institutional investors channel wealth is an important indicator of the commitment of the financial services industry to climate change.
Several global institutional investors are operating or interested in India, including Singapore-based GIC Holdings, Abu Dhabi Investment Authority, Softbank, Brookfield, CPPIB and CPDQ from Canada, ORIX (Japan), Sembcorp and APG (Holland), Goldman Sachs, JP Morgan, and Morgan Stanley.
A January 2021 report by InfluenceMap, a think tank focused on climate finance, found that the equity holdings of the largest asset management groups were misaligned with the Paris climate targets. For instance, many companies were under-investing in green technologies in four climate-critical sectors: Automotive; oil and gas production; coal production; and electric power. A more specific study by the same institution in August 2021 on 723 equity funds with over US $330 billion in total net assets, found that 71 percent of the ESG funds and 55 percent of climate funds were negatively aligned with Paris commitments. This shows that certain financial services firms are not even aligned with the Paris Agreement, let alone financing it.
Even those companies committed to the Climate Action 100+ have been falling short. Climate Action 100+ is an initiative with buy-in from over 600 institutional investors globally with assets of nearly US $55 trillion and that engages with large companies responsible for carbon emissions. A UN survey of 107 companies, many of them committed to the initiative, found that 70 percent of the companies could not provide evidence of including climate-related disclosure in their 2020 financial statements.<17>
The Indian government has introduced or streamlined various financial regulations to attract capital for green projects, including automatic approval for FDI, strengthening Power Purchase Agreements, establishing renewable energy parks and green corridors, and streamlining the bidding processes. It has also made efforts to address investors’ concerns for macro-economic resilience, currency risks, and political stability. Nevertheless, weaning large institutional investors away from brown investments will require efforts beyond streamlining financial regulations. For instance, a report by Urgewald reveals that some 4,488 institutional investors have made investments amounting to US $1.03 trillion in companies associated with the coal value chain. The United States leads the pack with over US $602 billion worth of investments in the global coal industry, followed by Japan and the UK. Commercial banks too, hold large stakes in the coal industry, with the Japanese banks holding the largest investments followed by the US and UK commercial banks. They collectively hold investments of almost US $166 billion.<18>
Another report, this one by the Climate Policy Initiative released in 2021, found that 38 of the 60 largest commercial and investment banks have committed to exclude direct financing to coal fired power plants and yet provided US $52 billion to the 30 largest coal power plant developers in the world.<19> Clearly, commercial banks are still finding it easier to invest in fossil fuels. Without incentives for green projects, any half- baked attempt at greening the financial system will be inefficient.
To that end, it is useful to examine the emerging power of shareholder resolutions. Exxon and Chevron shareholders this year launched a “rebellion” at the annual meetings. Activist investors forced the companies to heed to climate concerns through shareholder voting and resolutions. Similar shareholder activism for climate is emerging within banks, financial institutions, and manufacturing companies. A case study is the climate strategy adopted by CPP Investments, the firm responsible for investing assets of Canada Pension Plan. It has set itself apart from its peers by supporting 130 resolutions on climate-related shareholder resolutions since 2015.<20> In 2021 alone, CPP supported 19 shareholder resolutions that sought deeper disclosure on climate change risks and opportunities. They also voted at 42 companies against the reappointment of the chair of the risk committee (or an appropriate equivalent committee responsible for climate risks)—their votes resulted in 53 votes against directors, and material commitments and improvements on climate-related disclosures and practices at 17 companies.<21>
4. On Political Consensus for Climate Finance: The Mobilisation Imperative
The green ambitions, promulgated by the global leaders, can only be brought to fruition with a global political consensus on climate-related financial regulations that enable climate action. The policies have to be equitable and representative of a broader group of stakeholders, particularly developing nations such as India, which are pivotal in the fight against climate change. A fragmented effort by political leaders will only cause a setback to the current progress on global climate action. Green Transformation cannot be achieved unilaterally, and this underscores the imperative for mobilising global climate finance for climate action.
Greater cooperation on climate change will require the integration of economic and financial markets, particularly for the developing countries. This in turn requires additional support in financing, capacity building and technology transfer, so that developing countries are able to catch up with the global North without compromising on their economic and social development goals. The transition to a low-carbon future needs to be equitable and just, and the political elites must meet the challenge of fostering a global carbon-neutral recovery strategy.
Private investment for climate change needs to be galvanised quickly and it should complement spending by public agencies. Climate mitigation and adaptation should be the focus of policy and regulatory frameworks to buoy investments in green innovation—this will aid in producing and distributing economically viable technologies, increase efficiency, and reduce risk. In turn, it will create opportunities for governments to create industries, employment, and economic output.
Companies and investors are increasingly using ESG criteria when making investment decisions.
The imperative is for a centralised global platform that will encourage and facilitate active cross-border cooperation across financing, technology transfer, and capacity building. At the same time, a decentralisation process needs to emerge that enables sub-national governments and corporations to set local targets with accountability for achieving climate goals. Such a dual system of centralised resource mobilisation with de-centralised implementation can be instrumental in meeting climate goals.
Furthermore, customers, shareholders and the public are now acutely aware of climate change and are demanding more sustainable policies and practices; climate agenda is no longer dependent on a small group of stakeholders driven by vested interests. Companies and investors are increasingly using ESG criteria when making investment decisions. This should become a central bank-driven mandate for industries to help enhance climate-related disclosures and encourage climate change information dissemination. It will do governments well to heed the concerns of the public and actively contribute to climate mitigation and adaptation on a global scale.
The 26th Conference of Parties (COP26) is an opportunity to develop and galvanise consensus, particularly on climate finance. A green recovery will positively influence all forms of capital—physical, human, natural, and social. If the world can mobilise US $17 trillion for responding to COVID-19 and reconfigure the international financial architecture to ensure capital reaches where it is most needed, the international community can certainly gather geopolitical consensus for mobilising the requisite capital for fighting climate change. Investing in capacities for climate action will have percolating development benefits which, in turn, will lead to an improved economic world order; this is the message that needs to be promulgated and strengthened.
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Endnotes
Includes the Asian Development Bank (ADB), African Development Bank (AfDB), Asian Infrastructure Investment Bank (AIIB), European Bank for Reconstruction and Development (EBRD), International Bank for Reconstruction and Development (IBRD), and Inter-American Development Bank (IBD).
Such as the Global Reporting Initiative (GRI), Carbon Disclosure Project (CDP), Climate Disclosure Standards Board (CDSB), International Integrated Reporting Council (IIRC), and Sustainability Accounting Standards Board (SASB).
The working group is responsible for overall guidance on global macroeconomic policies, global financial imbalances, and global economic growth. It has been co-chaired by India since its inception.
<1> Delmotte et al. (eds.). Global Warming of 1.5°C. IPCC, 2018. pp 22.d
<2> The Independent Expert Group on Climate Finance. Delivering on the $100 Billion Climate Finance Commitment and Transforming Climate Finance. United Nations, 2020. pp 22.
<3> Climate Change Finance Unit. Climate Change Finance, Analysis of a Recent OECD Report: Some Credible Facts Needed. Department of Economic Affairs, Ministry of Finance, Government of India, 2015. pp 2.
<4> The Rockefeller Foundation. Reimagining the Role of Multilateral Development Banks. The Rockefeller Foundation, 2021
<5> Humphrey, Chris, and Annalisa Prizzon. Guarantees for development: A review of multilateral development bank operations. ODI, 2014. pp 27.
<6> The Independent Expert Group on Climate Finance. Delivering on the $100 Billion Climate Finance Commitment and Transforming Climate Finance. United Nations, 2020. pp 22.
<7> G20 Eminent Persons Group on Global Financial Governance. Making the Global Financial System Work For All. Washington DC: Heinrich Böll Stiftung, 2018. pp 39.
<8> G20 Eminent Persons Group on Global Financial Governance. Making the Global Financial System Work For All. Washington DC: Heinrich Böll Stiftung, 2018. pp 39.
<9> Humphrey, Chris. Are Credit Rating Agencies Limiting the Operational Capacity of Multilateral Development Banks? G24, University of Zurich, Intergovernmental Group of Twenty Four, 2015. pp17.
<10> Gottschalk, Ricardo, Lavinia B. Castro, and Jiajun Xu. 2020. Financial regulation of national development banks - NDBs. AFD editions, 2020. pp 14.
<11> TCFD. Task Force on Climate-related Financial Disclosures. TCFD, 2020. pp 68.
<12> TCFD. Task Force on Climate-related Financial Disclosures. TCFD, 2020. pp 13.
<13> Network for Growing the Financial System. Progress report on bridging data gaps. Network for Greening the Financial System Technical document, NGFS, 2021. pp15.
<14> SEBI. Business Responsibility and Sustainability Reporting by listed entities. SEBI. 2021.
<15> RBI Bulletin. “Green Finance in India: Progress and Challenges.” RBI. 21 January, 2021.
<16> Ministry of New and Renewable Energy, Government of India. Standing Committee on Energy. Lok Sabha. 2021.
<17> Davidson, Barbara, and Rob Schuwerk. The glaring absence of climate risks in financial reporting. Carbon Tracker Initiative, Flying Blind, Principles for Responsible Investment (UNPRI), 2021. pp 27.
<18> Urgewald. Groundbreaking Research Reveals the Financiers of the Coal Industry. Embargoed release GCEL finance research. pp 2.
<19> Climate Policy Initiative. “Coal Power Finance in High-Impact Countries.” Energizing Finance Research Series, 2021. pp 11.
<20> FSB. Task Force on Climate-related Financial Disclosures, Status Report, 2020. pp 61
<21> CPP executives, interview over a virtual platform, October 2021.
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