Impacts and risks generated by climate hazards, exposure and vulnerability are more extensively being observed and projected in many ecosystems and human systems worldwide.
This code red for humanity however remains measured, meaning every near-term action and measure that reduces emissions or adapts must be drastically implemented to preserve “a liveable and sustainable future for all”.
Given this scope, it is imperative “to take urgent action to combat climate change and its impacts”. This translates into businesses adopting actions that show they operate and make decisions in a responsible way.
Indicatively, as the global momentum on climate action continues, the financial sector stands to play an instrumental role in driving that change. Some recognise need to take action and demonstrate leadership through addressing changing climate risks and financing shifts in market demand and supply by directing capital and demonstrating to markets the emerging opportunities.
For instance, Central Bank of Kenya has issued Guidance on Climate-Related Risk Management to the banking sector in October 2021 to guide banks to manage and integrate climate-related risks in their governance, strategy, risk management and disclosure frameworks.
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In practice, more institutions are making decisions and actions that take into account solving the climate challenge. Some of the actions can broadly be categorised as follows:
Climate risk management. Climate change presents unprecedented financial risk, including physical ones from acute weather events or longer-term climate trends such as sea level rise. They can arise from transitional risks, changes in policies, technology or consumer preference aligned with transitioning to low-carbon resilient economies globally, and achieve ‘net zero’ emissions in the long term.
This has led to robust disclosure of climate risk exposure, guided by the likes of Financial Stability Board’s Task-Force on Climate-related Financial Disclosures, where lenders are stress testing against extreme climate impacts on the value of their assets and market stability. This allows them to be proactive in understanding and managing climate risks and assess their portfolio, pipeline and new investments.
Development of new sustainability-related products: Financial institutions are deploying “green” products and services, such as sustainability-linked loans, green bonds, carbon commodity products, environmental indices that provide consumers transparent options to reduce negative environmental and indirect impacts, and/or provide environmental benefits.
Low carbon emissions portfolios: Some financial institutions are introducing indirect but potentially powerful new mechanisms and techniques to reduce the carbon emissions of loan books and investment portfolios. In addition, and in line with declarations on phasing down coal, new strategies and approaches are being implemented by institutional investors to manage the risks stemming from exposure to fossil fuel companies.
Low carbon and energy efficiency finance and investing: There is growing recognition that the world needs to shift capital and investment from high to low carbon activities if we are to avoid dangerous climate change outcomes thus more financial institutions, such as banks, insurance companies, pension funds, fund managers, mutual funds, sovereign wealth funds, charities and endowment funds are allocating capital and steering financial flows towards more investments and assets that are necessary for transitioning low carbon, climate resilient activities.
Climate adaptation finance and investing: There is growing need to support adaption measures because it is too late to avoid some impacts of climate change, especially in developing nations, where the physical risks are high and the capacity to respond is low.
This calls for financial sector’s involvement in the nexus between development aid and adaptation financing, such as assessment of community vulnerability to natural disaster, developing tools to manage adaptation risks, investment and insurance in climate-smart agriculture.
Engagement with companies: Lenders have potential to contribute to climate action by engaging with companies in which they invest. The companies are integral to the activities of finance institutions, both as a customer for their services, as well as issuers of debt and equity securities that are core components of a global investor’s investment portfolio. Thus, financial institutions can exercise ownership rights to influence and change the way companies behave in relation to climate change.
