Climate Change: Is the sum of the parts enough?

The landmark Paris Agreement on Climate Change, signed in 2016, set the target of keeping the global temperature rise this century well below 2 degrees Celsius above pre-industrial levels; with efforts pursued to limit the temperature increase to 1.5 °C. To reach this target, global greenhouse gas emissions (GHG) will need to drop by half by 2030, and then reach net-zero by 2050.

The impact of GHG is not only adverse climate change consequences, as significant as that is, but also  the significant public health issues caused by pollution, biodiversity loss and other social impacts such as poverty traps, migration, security and conflict. These affect each one of us, as individuals and as organisations, wherever we live.

To put the scale of this challenge into perspective, according to the International Energy Agency (IEA), to deliver the capacity of clean energy needed to meet net-zero emissions, by 2050, the world would need to build the equivalent of:

• the largest hydrogen electrolyzer in operation every hour;
• the world’s largest existing solar park every two days; and
• the largest known carbon capture and storage (CCS) project every week.

With actions of this magnitude required, the big questions some are asking include:

1. Are we taking this seriously enough?
2. Are we taking impactful action or still having academic discussions?
3. Do we fully understand what needs to be done to meet the Paris Agreement targets?
4. Can we actually realise the change required given current constraints in global resources including technology and time?

The real issue, I believe, is not that the global stakeholders do not appreciate the criticality or lack the commitment to managing climate change, but that climate change is too big an issue with such far reaching consequences. There is no one country or organisation that is responsible or has a clear mandate to resolving challenges posed by climate change. We do not currently have one clear global plan that we can all work towards to meet the required targets. We are relying on complex, sensitive, and uncontrolled interaction of different stakeholders doing their part to manage climate change in the hope that the sum of this parts will get us to where we need to be. My fear is that we may find out too late that the sum of these parts is not enough. 

We need to understand how the various factors influence one another within the system and to have a transformational shift to a net positive position –  avoiding harm only at this stage can no longer help us combat climate change and the associated adverse impacts. It is important to note that applying this systems thinking involves various dimensions to climate change which cannot be effectively covered in one article. In this article, I therefore focus on the key points of the following four areas only:

1. Managing the broader implications of Climate Change
2. Role of Government
3. Financing
4. Accounting, disclosure and measurable metrics

 Managing the broader implications of Climate Change

Focusing on managing climate change but not its adverse effects is going to increase the impact and significance of the resulting social, economic and environmental issues we are already experiencing.  Looking at Kenya, as an example, the key drivers of the economy are agriculture, livestock, tourism, forestry, and fisheries – all climate sensitive – making Kenya’s social and economic development vulnerable to climate change. The incidents of drought, floods and landslides, which we used to experience once every 5-10 years, are now becoming an annual occurrence resulting in loss of lives, livelihood, food shortages, poverty traps, migration, increased insecurity and conflict. These negatively impact on a healthy ecosystem and on the security of resources that we use. More important, the regularity of occurrence is increasing our vulnerability thereby reducing our capacity to effectively recover from these disasters.

There are many ways of managing these broader impacts of climate change including fiscal policy, capacity training, introducing impact management measures and innovative use of technology. One such potential private sector impact management technique worth exploring further is insurance. It is particularly under-utilised in developing countries (for many valid reasons such as lower disposal income and lack of appropriate products).

In 2019, the estimated global economic losses from natural disasters was US$232 billion[i], of which only US$71 billion was insured. For low income nations, the portion uninsured is often in excess of 90%.

There are some good examples of how the Insurance Industry is evolving to deliver on some of these impact management measures but some may argue not at the pace required. As an example, a Kenyan insurance company, APA Insurance Ltd, developed an innovative insurance product where payments are linked to easily measured environmental conditions known as an “index” directly connected to the loss of agricultural output covering factors including the level of rainfall, yields or vegetation levels as measured by satellite. This insurance cover is provided to over 350,000 smallholder farmers.[ii]  The company won the 10th European Microfinance Award in November 2019 for this initiative.  

Minister Lenert, who chaired the High Jury of the European Microfinance Award, noted that: "This year's Award illustrates that inclusive finance has an essential role to play in strengthening the resilience of vulnerable communities to the effects of climate change, which threaten the livelihoods of disadvantaged communities, especially those relying on agriculture, forestry or fisheries.”[iii]

 Role of Government

Governments should have a “whole of economy perspective” and utilise appropriate tools to deliver on the climate change and sustainability agenda given their spending capacity as well as role as regulator. Governments are the regulators who decide the rules of industrial, climate, energy and labour market policy and have significant influence as investors in their own rights and owners of state institutions and key infrastructure. They can, through their own expenditure or policy and regulations, direct efforts into the required education, R&D, technology, infrastructure and social protection, that is required to manage climate change and its broader impacts.

Through involvement in multilaterals, Governments can also be the most effective in extending their role beyond their national boundaries to the global space.

Finally, Governments need to look at what approach will be more effective for them in lowering the risk for the private sector to deliver on the initiatives required to combat climate change and to ensure through regulations that investment and operational decisions are based on true costs, using legislation, disclosure requirements, taxes, penalties or other mechanism that bring externalities into account. A good example is carbon pricing – either an actual carbon emission price (or in some cases seen as taxes and levies) is charged by the State or a carbon shadow price is factored into the planning of major projects where current market prices do not reflect these impacts. Both approaches are effective, even though shadow prices are fictional, as they introduce an approximation of costs into the economic evaluations.

 Financing

There are several estimates available on the investment required for an orderly transition to a low carbon, sustainable global economy - these range from US$1.6 trillion to up to US$6 trillion per year. The different sources of estimates and the range shows that there is no clear answer. These investments are needed to replace ageing infrastructure in advanced economies and to accommodate higher growth and structural change in emerging markets and developing countries.

The challenge is that time is required to advance some of the required technology for cleaner energy and reduce costs to a level which de-risks the required investment for wider use. For instance, some investments in hydrogen have been ongoing for more than 20 years without viable business delivery models that make that profitable. Private sector may be discouraged to make such investments, but this is where Government through policy, regulations and finance initiatives, such as blended finance (a structuring approach which allows organisations with different objectives to invest alongside each other while achieving their own objectives, whether financial return, social impact, or a blend of both), can lower the risks and level of investments required making these viable options for private investors.

There is also the argument that a disconnect exists in the distribution of wealth between those who are negatively contributing towards climate change and those impacted. For example, Africa is estimated to contribute only 3% of the Cumulative Global CO2 Emissions by 2040, yet is facing some significant negative impacts from climate change as a result of its dependency on the extractive industries as well as climate-impacted industries such as agriculture, livestock, tourism, forestry, and fisheries. The investment required to de-risk technologies and optimise on costs should therefore be borne by the developed countries, with the high carbon emissions per capita, and transferred to the developing counties, with the low carbon emissions per capita. This will support a “just transition” to cleaner energy sources provided these developing countries are, in the meantime, also looking for ways to pursue minimisation of their net negative impact on the environment and society. In Kenya, there is already a good uptake of alternative energy sources, including wind, solar and geothermal which should continue to be explored and developed further.

As mentioned above, it is important to manage climate change and its resulting socio-economic impacts and the financing options should reflect this balance. It is expected that the current Covid-19 pandemic may actually have some positive impact toward achieving this between green and other forms of sustainable finance e.g. social bonds.

 Accounting, Disclosure and measurable metrics

Increased disclosure and inclusion in financial statements are ideal but in themselves are not going to drive the right behaviours if sustainability considerations are not included in the investment and operational decision-making processes i.e. as part of valuation models, budgeting and forecasting. Focus should therefore be on ensuring actual or estimated costs – investments and impacts – are incorporated in decision-making by businesses, financial sector and regulators through appropriate principles, frameworks and pricing of externalities. The focus to date has been on disclosure which does not necessarily mean the information will be incorporated into the decision-making process.

For example, Mahindra & Mahindra Ltd[iv] (part of multinational Mahindra Group), by implementing internal carbon pricing in 2016 (i.e. pricing of externalities) has helped the company make better  investment decisions which not only reduced their emissions by 25% against a 2016 baseline but also allowed for the carbon pricing revenue to be used as an “internal green bond” to build wind turbines,  invest in solar power and potentially invest in future water or waste management projects. This is an example of how a company can leverage on carbon pricing to do make the decisions that allow it to do better business.

Company financial statements and disclosure remain key inputs into the decision-making process and the issue of imperfect information with no standardisation or consistency in the disclosure requirements or measurable metrics being used, remains. Good initiatives are under way with collaboration between key parties such as the Sustainability Accounting Standards Board (SASB) and the Global Reporting Initiative (GRI) coming together on a joint workplan and the Big Four accounting firms recently announcing they are coming together to unveil a reporting framework for ESG standards.

Although I fully support the efforts around global convergence of standards for measuring and reporting on ESG, my concern is the use of the traditional basic accounting principles. Application of these principles will result in a focus on the investments and expenditures and not on the actual impacts which are harder to identify and measure. There is a growing realisation, especially with the current Covid-19 pandemic, that traditional models of income and production valuations may not necessarily be good indicators for future income generation. Instead, organisation need to look beyond their financial and physical assets as well as past income/profit trends and focus more closely on their intangible assets, such as social, human or natural capital, to fully evaluate future prospects.  The issue is that a majority of these intangible assets are off-balance sheet and not directly attributable to the organisation.

Some initiatives such as the Task Force on Climate-related Financial Disclosures (TCFD), created by the UK Financial Stability Board (FSB) in 2015,  is trying to address this but incorporating the requirement for disclosure also on the organisation’s business, strategy and financing planning, risk management processes as well as governance processes.

 So I come back to the question: are we taking climate change seriously enough? Last month at the UN General Assembly, probably one of the biggest game changers in the politics of cutting carbon was announced. Despite China being responsible for around 28% of global greenhouse gas emissions, the Chinese President, Xi Jinping, announced that China would cut emissions to net zero by 2060. This follows the EU’s commitment to be carbon neutral by 2050. So, the big public commitments are being made.

Current national targets would take the world to at least 3°C above pre-industrial levels[v] (significantly higher than the Paris Agreement targets). Unfortunately, COP26, probably the most important international meeting on the climate emergency since the Paris agreement was signed in 2015, has been delayed by a year because of the coronavirus crisis. This will possibly create delays in the submissions of the nationally determined contributions (NDCs) by UNFCCC parties and also us down towards having one consolidated action plan.  

It is our world, our present and our future. We all therefore need to keep playing our roles as individuals, businesses, financial institutions, civil society organisations, and Government, to steer us to a more inclusive and sustainable path. I’m interested in hearing your views and perspectives as well as examples of initiatives that can steer us down the path of a more sustainable future.

 Note on the Author: Reshma Shah is the Founder and CEO of InteStrat Services Ltd (offices in Kenya) and also a Partner and Senior Associate at Kina Advisory Ltd (offices in the UK and Ghana). Reshma has contributed to this article in her personal capacity and the views expressed are her own and do not necessarily represent the view of InteStrat Services Ltd or Kina Advisory Ltd.  

[i] Economic loss from natural disaster events globally from 2000 to 2019 published by Statista https://www.statista.com/statistics/510894/natural-disasters-globally-and-economic-losses/

[ii] Agriculture Insurance Wins APA Sh11 Million European Award, Business Daily, 25 November 2019, https://businesstoday.co.ke/apa-insurance-wins-110k-european-microfinance-award-for-index-based-agriculture-insurance/

[iii] APA Insurance Ltd receives the 10th European Microfinance Award in recognition of its response to “Strengthening Resilience to Climate Change”, EIB Organisation, 22 November 2019 https://www.eib.org/en/press/all/2019-318-apa-insurance-ltd-receives-the-10th-european-microfinance-award-in-recognition-of-its-response-to-strengthening-resilience-to-climate-change

[iv] Carbon Pricing Leadership Coalition – Carbon Pricing Leadership Project, 2019/20 https://www.carbonpricingleadership.org/

[v] “Cop26 climate talks in Glasgow will be delayed by a year, UN confirms”, Guardian, 28 May 2020 https://www.theguardian.com/environment/2020/may/28/cop26-climate-talks-in-glasgow-will-be-delayed-by-a-year-un-confirms