Structural changes need to be brought to allow different financial sectors to invest in the green future of developing nations.
This piece is part of the essay series, Shaping our green future: Pathways and Policies for a Net-Zero Transformation.
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.
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.
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.
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>
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. Download the PDF of the report here
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Mannat Jaspal is an Associate Fellow with the GeoeconomicsRead More +
Akshay was the Director of ORF Mumbai and HeadRead More +