Baringa at COP28

As expected Sunday at COP28 brought new attendees; alongside interested citizens making the most of the green zone space and events there was a noticeable uptick in finance sector representatives as noted in this Bloomberg piece.

So, what is the role of financial institutions at what is fundamentally an intergovernmental climate negotiation?

1. To influence policy; both in the real economy and within the financial sector.

Historically much of this happened at New York Climate Week in the run-up to COP, where the private sector would meet with governments present for the UN General Assembly. As COP itself has grown in stature it attracts not just governments but also financial policymakers themselves. Given the critical role of the Basel capital framework for banks or the Solvency II prudential regime for insurers (with their substantial asset holdings) it's important that barriers to capital flow toward climate and the transition are understood and addressed where needed. And at the same time, stable (international, national and subnational) governmental policy is needed to provide a basis on which that capital can be committed toward companies and assets driving the transition toward 1.5 degrees.

2. To exchange ideas.

This is genuinely a two-way exchange; banks, asset managers and insurers host events and participate in panels to share their progress, challenges and innovations. But whether in these settings or through meetings such as the Climate Safe Lending Network event I attended yesterday, these are also opportunities to learn from peers and those in adjacent parts of the climate finance ecosystem. I'll share more in articles over the coming days about the key concepts circulating at COP including adaptation, blendedfinance and the just transition.

3. To do deals.

With so many governments and companies present, this really is the 'climate trade show' side of COP. Whether innovative start-ups looking for capital to scale, through to governments looking for financing for climate adaptation plans, COP offers an opportunity to connect. These connections can be to build and develop relationships, or as a platform to announce new transactions. Those range from the big (the new Alterra $30bn facility) to the bold (the agreement under ADB's Energy Transition Mechanism to retire the Cirebon-1 coal power plant using a novel financing agreement).

Monday was finance day at COP28, driving an enormous amount of activity and announcements and continuing to raise awareness of climate action globally and more locally - Emily Farrimond struck up a conversation with our Bangladeshi taxi driver about the physical impacts of climate change on Bangladesh as a country less than five metres above sea level.

Once inside the COP venue, a major theme was transition finance. Whilst there has been a lot of noise around COP being held in a major energy economy it has also helped to give a tangible edge to the discussions on decarbonisation. Looking across the newsflow from today, a handful of things stand out:

1. There are a growing number of frameworks (which we touched on in our The critical role of frameworks in unlocking transition finance without unleashing greenwashing article) including a new release from the Monetary Authority of Singapore. Part of this is acknowledging the transition trajectory will differ between markets, which we’ve been unpacking with clients through our Climate Base Case Scenario.  
 
2. That work on frameworks is not yet translating into transactions and capital flow at scale - Daniel Hanna spoke on a panel about a market-leading transaction supporting an airline to decarbonise ground operations and increase sustainable aviation fuel uptake, but we need more. Some of this will require more risk taking by banks, supported by supervisors and regulators, given the novel technologies

3. Central to operationalising is incentives, in which context it’s notable to see Glasgow Financial Alliance for Net Zero (GFANZ) continuing to work on a wider range of metrics to measure banks’ contribution to the transition including exploring avoided emissions.

4. Robust controls remain critical. With transition finance having such broad definitions predicated on sector and geography, reputational concerns have the potential to hold the market back if not managed in a mature way.

Tuesday was the Just Transition thematic day here at COP28. The finance sector’s relationship with the social dimension of the transition is an evolving one. One way of thinking about this is the two types of relationships financial institutions play. Firstly as providers of capital to companies of all sizes who employ individuals, and how these individuals will be impacted through the transition. But secondly and just as importantly, as providers of retail financial services to individuals themselves – something which was thrown into sharp relief for many Western financial institutions with the energy price volatility in recent years. 

Financial institutions are having to address the just transition as they develop transition plans – and particularly in light of the Transition Plan Taskforce recommendations to integrate both nature and social components of the transition into planning. Like other components of climate, this can be very location specific; whilst we often think about the transition playing out on a sectoral basis, companies and those they employ can be centred on particular locations.

Against this backdrop, one of the most notable resources launched at COP is a guide developed by United Nations Environment Programme Finance Initiative (UNEP FI) and International Labour Organization on ‘Just Transition Finance: Pathways for Banking and Insurance’. A handful of things that stood out for me:

• Just transition has a different context for each financial institution based on their strategy and business model. It’s critical to understand this to determine what action to take
• That in itself requires meaningful engagement with those a financial institution can partner with, or needs to reach, in supporting a just transition
• There needs to be a focus on the most vulnerable, although the ability to do so might need innovative thinking on partnerships
• All of this has a commercial lens; we’re at a very early stage but just transition financial products have a role to play, which can support financial institutions’ commercial objectives.

At heart this links to the core role of banks and insurers – providing lending products which spread high upfront costs (such as electric vehicles or home retrofits) over time, or providing insurance cover to ensure individuals are not exposed to undue risks (including conventional home insurance in a context of increasing extreme weather events).

I’m hopeful we’ll see more work on the role asset managers, especially pension funds supporting the retirement of individual pension holders, in the coming months.

Wednesday was the last day of COP28 negotiations before a ‘rest day’ – nominally so that the negotiators who have been working day and night on the decision text can have downtime. From talking to clients who are staying at COP into next week, many of them are also looking forward to the break!

Colin Preston, Emily Farrimond and I attended the Sustainable Finance Forum yesterday hosted by United Nations Environment Programme Finance Initiative (UNEP FI) and Principles for Responsible Investment. One focus topic, which has been prevalent all week at COP, is adaptation finance.

It’s a topic which has taken some time to come to the fore – for those looking for a primer, the Driving Finance Today for the Climate Resilient Society of Tomorrow paper I contributed to in 2019 is still a good place to start.

The increasing frequency of extreme weather events means everyone, including financial institutions, are having to focus on how to integrate adaptation and resilience alongside a focus on mitigating climate change by reducing emissions.

For the finance sector, this can be a combination of dedicated financial products (for example parametric insurance which pays out if temperatures exceed certain levels), and ensuring adaptation is incorporated into activities and assets being financed (for example nature-based solutions to provide shade in housing developments). There are also examples of pure-play adaptation assets, such as flood defences, which require governmental intervention.

But today finance isn’t flowing to any of those activities – the latest UN ‘adaptation gap’ report suggests that only 10% of the finance needed for adaptation is being provided today, with total needs potentially as large as $366 billion a year.

There were examples at COP of transactions that do incorporate adaptation – but we need to scale these up dramatically. It was great to hear my former teammate Alex Kennedy from Standard Chartered Bank get a shout out at the event from Dipeeka Seeruttun Ramgolam for the work they are leading together to create an adaptation and resilience guide for financial institutions, which will make it easier for banks to identify activities in need of financing.

As the Baringa team head home from COP28 I wanted to reflect on a topic that's close to my heart - nature. What did we hear at COP?

1) There is an urgent need for capital as an incentive for the base of the mitigation hierarchy, avoiding harm to nature. Whilst voluntary carbon markets have had a torrid year, they remain critical in allowing those who want to pay for nature protection outcomes to do so. The challenge is ensuring consistency of the claims made by those paying for such outcomes - this isn't about being 'carbon neutral'!

2) Whilst nature is a broad topic, tackling portfolio deforestation is likely to be top of financial institutions' 'must do' list in 2024 due to a combination of its' specificity, existing action, and the incoming EU CSDDD.

3) Engaging with the agriculture sector will also be high up that list - many banks are setting Net Zero targets for the sector in 2024, and the structure of the sector means engagement will have different characteristics to many other hard-to-abate sectors.

4) Incentives will be critical across agriculture and many other sectors that are dependent on nature. The dialogue about taxation reform seems to be growing at COP - and connect to the target in the Global Biodiversity Framework for $500bn of annual incentive reform by 2030. My hope and expectation is we'll see a lot more focus on this as we head to the CBD COP16 in late 2024.