Greenflagging the biggest reallocation of capital ever seen

The biggest reallocation of capital in human history might just go unnoticed. While we doomscroll past updates of worsening climate change, environmental disasters and an apocryphal end of the world - the finance bros are trying to do something about it.?

It’s an existential threat the magnitude of which eludes a majority of the human race because we are cursed with the terrible malady of myopia. The calls to ‘act now!’ fall on deaf ears, activism is ridiculed and accused of creating panic, and the inheritors of this ailing planet – our own children – detained for showing us where we went wrong.

As we zoom past deadline after deadline to keep carbon emissions in check and arrest the rise in global temperatures, stakeholders capable of wielding any kind of influence must do everything in their power to – well –?‘act now’!

Aside from interventions at the highest echelons of policymaking, banking can make meaningful contributions to the cause. The principle is simple – money makes the world go ’round, and banks can choose to divert it towards greener pursuits.?

But let’s take a realistic view of things and mince no words – banking is a business and banks won’t take on any risks that may be detrimental to their health. So what’s the incentive for green finance for banks??

It will create the biggest reallocation of capital ever seen as we chase net-zero emissions.

1. Close to 90% of the emissions are?targeted ?for reduction under commitments to go net-zero.
2. Through the Glasgow Financial Alliance for Net Zero (GFANZ), the largest coalition of banks committed to transitioning the global economy to net-zero greenhouse gas emissions, more than $130 trillion of capital has been?earmarked for the transformation ?to net-zero.
3. Currently, banks pour around 65% of their capital into high-emission assets. But if we achieve net-zero by 2050,?70% will be spent on low-emission ?ones according to some estimates.
4. The issuance of green bonds?doubled ?to half a trillion dollars in 2021, and the trend is expected to continue.
5. This reallocation will create a demand for climate-friendly goods and services, along with clean raw materials and infrastructure required for their production.?

Corporate lending is already taking cues from climate action initiatives

Mark Carney, former governor of the Bank of England, UN Special Envoy for Climate Action and a founding member of the GFANZ, remarked in 2019, “Companies that don’t adapt (to deal with the climate crisis) will go bankrupt without question.”

The question of valuation and profitability is as important for lenders as it is for companies. Thanks in part to this, and in part to the need to fall in line with growing regulatory reporting and compliance requirements, lenders are increasingly seeing the value in financing companies that are adapting.

For instance, BlackRock, the world’s largest asset management company, has created a circular economy fund for companies that engage in sustainable, closed-loop production. Companies in its portfolio include Adidas which is tackling plastic waste through such a production model.

Funding incentives like these spur environmental, social and governance (ESG) activity among the corporates that stand to benefit from them as well. And this is important for both lenders and companies since valuations are slowly breaking free from bottom lines and aligning closer with ESG imperatives (BP’s stock prices plummeted and billions of dollars were lost following the oil spill at Deepwater Horizon).

In fact, there is evidence to corroborate that companies more committed to their ESG requirements outperform their low-sustainability counterparts. A 2014 study showed that 90 companies classified as high-sustainability performed better in terms of stock market and accounting than 90 low-sustainability companies.

A $130 trillion smokescreen?

The Reserve Bank of India (RBI) conducted a survey last year to determine the status of climate risk and sustainability in scheduled commercial banks.?

There is recognition of the urgency of the situation and its material threat to banks' business. Most of the banks surveyed have decided to gradually reduce exposure to high-carbon emitting businesses in the future. Some have mobilised new capital towards green lending and investments. And while most banks have in place loan products for sustainable lending, some have also launched green deposits.?

But largely, banks aren’t walking the talk. The RBI survey found —

1. One-third of the banks were yet to assign responsibility for overseeing initiatives related to climate risk and sustainability.
2. Very few banks included climate risk, ESG and sustainability-related KPIs in the performance evaluation of their top management.
3. Most of the banks do not have a separate unit for ESG and sustainability initiatives.
4. Most of the banks surveyed did not align their climate-related financial disclosures with any internationally accepted framework.

On the global stage, lenders’ shortcomings appear even more stark against the backdrop of ceaseless, flashy climate action conferences. The GFANZ, despite its $130 trillion commitment to green investment, has already?spent billions ?on fossil fuels.

Why do financial institutions hesitate to go green when the opportunity is massive?

The G-20’s Financial Stability Board (FSB) has identified four climate-related financial risks that hold lending institutions back and must be tackled - disclosures, vulnerabilities analysis, regulatory and supervisory practices and tools, and?data.?

1. A standardised?disclosure framework?for companies and individuals that is intertemporal, comparable and easily used in decisioning can help lenders better reallocate funds towards greener investments and optimally price risk.
2. Macro-level analyses of?vulnerabilities to financial stability?due to climate events are the need of the hour. Such analyses must be envisioned as long-term activities and incorporated into the State’s routine monitoring exercises.
3. Based on the aforementioned actions, regulators and authorities must?codify practices and develop tools?to help them better supervise all regulated entities when it comes to organisational strategy, risk management, and governance.

Data will provide the neural network for risk management

The RBI’s survey?found ?that most banks didn’t have access to?sufficient data?for climate-related risk assessment. The processes to measure and monitor climate-related financial risks were also not well developed. In a country as geographically diverse as India, the lack of quality, granular data hinders the risk modelling of future climate events.

I believe that the first three risks can only be managed if the vast gap in data availability is first addressed. It is only through high-quality, comparable data that companies will be better positioned to file their disclosures and authorities will be able to develop practices and tools to effectively regulate the space.?

Creating a comprehensive data repository compatible across sectors and geographies that also facilitates reliable risk assessment is indeed a tall order, but commendable efforts are already underway. For instance, Singapore’s Project Greenprint aims to drive green finance by empowering an efficient ESG ecosystem. It aims to connect green FinTechs with investors, lenders and corporates and achieves this through three pillars:

1. ESG disclosure portal: To access and manage ESG performance data with consistency and clarity.
2. Data orchestrators: Platforms that aggregate and facilitate access to ESG and ground-up data sources.
3. ESG registry: A blockchain-based network of registries that records and maintains the origins of ESG certificates and data.

Closer home in India, public digital infrastructure has already gained currency and enjoys strong institutional backing. The case for an open infrastructure dedicated to the storage and exchange of climate-related data that takes after the India Stack is a strong one indeed.

That's all from me this week!

Written by?Rajat Deshpande