China Water Risk (CWR): The demand for financing in green growth is on the rise. Having worked at the forefront of climate risk and green finance for the past 20 years, how do you see the progress of climate finance so far both globally and in Asia?
Dr. Christine Chan (CC): We can point out several important trends in climate finance:
First, the Paris Agreement commits the Parties to provide resources to address mitigation and adaptation equally. The Green Climate Fund, the financing mechanism of the UNFCCC, promotes this balance in its mandate, yet the vast majority of global resources in the past 20 years have been spent on mitigation—clean tech, alternative fuels, renewable energy, carbon markets—while very little has been spent increasing resilience and reducing vulnerability of populations and ecosystems.
The vast majority of global resources in the past 20 years have been spent on mitigation…
…yet climate adaptation is arguably going to emerge as the more powerful long-term solution
Adaptation is arguably going to emerge as the more powerful long-term solution as we see continued trends of increasing CO2 levels and record-breaking temperatures. Yet the proportion of private finance devoted to climate adaptation is miniscule. Why? Adaptation strategies are long-term which has kept them in the domain of public finance. They include community engagement on climate risks, food and water security through sustainable resource management, disaster reduction planning, early weather warning systems, and sustainable urban development. Private sector hasn’t adequately explained the business case for adaptation initiatives, and investors don’t see a path to quick returns. I think we can do better, and more options will present themselves as niche approaches like sustainable finance, ESG investing, or impact investing become more mainstream.
Another trend we’re seeing is increased activity in green funds, green bonds, sustainability indices & green stock exchanges
Second, we’re seeing increased activity in green funds, green bonds, sustainability indices and green stock exchanges. The International Capital Market Association’s (ICMA) Green Bond Principles were recently complemented with Social Bond Principles and Sustainability Bond Guidelines, all of which may help enhance flows to climate finance. In 2016, Luxembourg launched the world’s first green stock exchange (LGX), requiring issuers of financial instruments to dedicate all their raised funding to green investments. Poland and France have issued sovereign green bonds, with Philippines, Morocco, Nigeria, and Bangladesh expected to follow this year. The World Bank issued the first green bonds based on business actions toward the UN Sustainable Development Goals.
It’s important to keep in mind that effectiveness of green bonds in addressing climate goals is linked to use of proceeds, and is a topic of intense debate. Moreover, liquidity in the green bond market is still lacking, putting off institutional investors, yet the momentum is growing as sovereign issues increase. This is one area where the Hong Kong government has declined to lead, despite outside policy recommendations to strategically issue a sovereign green bond.
Third, regarding Asia-led climate finance, in recent years China has shown strong political will to transition to a cleaner energy mix by setting clear legal frameworks and elucidating environmental policies in its 5 year plans. Its 13th 5 year plan establishes the mandate for a nationwide green financial system. As I’m writing, China is preparing to launch a nationwide emissions trading system that, if successful, could begin to address about half the country’s emissions-related pollution and dwarf the European Emissions Trading System (ETS).
“…the US is ready to give up its leadership role in climate finance & China is eager to lead”
In the international policy arena, it has become clear that the US is ready to give up its leadership role in climate finance and China is eager to lead. I would encourage Asian governments and institutions to be more active in creating and promoting adaptation solutions. For some populations and ecosystems—small island developing states, glacier-fed watersheds, coral reefs—the game is nearly over.
CWR: China has the world’s largest climate-aligned bond market and issued USD36bn worth of green bonds in 2016. Have these bonds been well-received? What improvements are needed?
CC: I recommend reading ‘Roadmap for China: Green Bond Guidelines for the Next Stage of Market Growth’ (jointly published by the Climate Bonds Initiative (CBI), International Institute for Sustainable Development, and the Foreign and Commonwealth Office). China’s green bond issuances have been well received domestically, but less so internationally, which is problematic, as China seeks to raise considerable sums of money from international capital markets to meet its development goals.
“China’s green bond issuances have been well received domestically, but less so internationally…”
One aspect that may be confusing potential international investors are China’s multiple domestic green bond standards, which are not uniform, and are issued independently by the People’s Bank of China (PBOC),the National Development and Reform Commission (NRDC), investment associations, and regulatory commissions—i.e. there can be many, specific definitions of a Chinese green bond, and conducting the due diligence and aligning the results to defined investment strategies can be time consuming. A specific example: CBI standards and the Green Bond Principles’ (GBP) recommendations do not include coal, large hydropower, or nuclear energy as eligible projects, while they are included in the collective set of Chinese standards. However, progress may be imminent, as PBOC and the European Investment Bank (EIB) have announced a joint initiative to strengthen frameworks for green finance, including a review of existing green bond classifications.
The key issues are multiple domestic green bond standards & a lack of standardisation among second party verifiers
Another issue: second party verifiers of green bond issuances in China (and other countries) lack standardisation in their verification processes, again resulting in increased costs for potential investors as they struggle to understand how the green bond credentials align with international standards. Yet another issue with second-party verifiers: they may not be fully independent reviewers of green credentials, as the verifiers often are engaged to help issuers develop green bond frameworks AND review them. This scenario clearly calls out for fully independent reviews to prevent false environmental claims.
I would like to see some innovative mechanisms for preventing environmental fraud, globally, without singling out specific countries. I think there’s promise in using distributed ledger technologies like blockchain to verify claims of sustainability or use of proceeds, as the individual verifications at each step of the process are public and can be checked by anyone. The GBP recommend creating performance indicators for measuring the environmental impact of investments.
“…there is promise in using distributed ledger technologies like blockchain to verify claims of sustainability or use of proceeds”
I think we could explore the idea of investor-led penalties (raised interest rates payable to bondholders has been suggested) if the green benefits claimed by issuers aren’t delivered. These are some ideas for combating greenwashing that deserve a closer look—no doubt there are many more. If I can raise the funding these are the issues I would like my nonprofit to tackle next.
CWR: As an advisor to the Climate Bonds Initiative, you helped create the state-of-the-art Water Climate Bond Standard. Has this standard proven to be useful for investors? What is the next step?
CC: Four billion people live in water-scarce areas, according to OECD, 2.4 billion don’t have adequate sanitation, and by 2030, across Asia, the World Bank is projecting a 70% increased water demand just for energy and industry. All this is happening while massive glacier systems are melting and flowing into the sea.
My hope is that the CBI Water Climate Bond Standard will help issuers and investors:
- understand the connections between water and climate, not just in nature, where water and climate systems are inextricably linked, but also in business and investment cases;
- understand how investment-worthy water projects can contribute to climate change mitigation (e.g. wastewater treatment, waste energy recovery), and adaptation (groundwater recharge, aquifer storage, rainwater harvesting, flood defence and monitoring systems, water recycling);
- promote market solutions to conserving an increasingly scarce resource.
The Phase 2 Standard addresses nature-based solutions in water infrastructure & will be available for public comment later this year
Phase 2 of the Water Climate Bond Standard addresses nature-based solutions in water infrastructure, specifically green or hybrid types of infrastructure. Examples include forests and wetlands that filter water as well as protect from storm surge, providing a natural defence against typhoons; and natural aquifers for storing drinking water, providing flood protection, and mitigation drought. The Phase 2 Standard will be available for public comment later this year, and hopefully published soon afterwards. Dr. John Matthews, who leads the Alliance for Global Water Adaptation (AGWA), has been the driving force coordinating the international consortium that has developed the water climate standards.
CBI also has working groups underway to address hydropower, marine system bonds, and agriculture, forests and land use—all of which include water as a major component, underscoring what a critical connector of livelihoods and ecosystems water is. I think this knowledge is quite longstanding in science and environmental communities, but still a nascent idea to businesses and investors and some governments. Water can also be viewed as a connector for investment approaches and market solutions.
CWR: What role can impact investors play in addressing climate and other social and environmental challenges?
CC: If impact investing can achieve mainstream traction, I think it can play an enormous role. We live in a world of starkly diverging realities: global capital markets are estimated to be worth hundreds of trillions of dollars, while the World Bank estimates nearly half the world’s population survives on less than $2.50 a day. These numbers speak to a dramatic, and deeply troubling discrepancy between global wealth and individual poverty.
Can impact investors achieve both high ROI and high impact? There is of course a wide spectrum of companies who achieve both returns and impact to varying degrees. One of our leading experts describes the sweet spot and how to find it: look for unknown players, trading in inefficient, illiquid markets, with high cost of due diligence and information asymmetries. No one knows they’re there yet, and that’s where the potential on the spectrum is found.
All of the UN Sustainable Development Goals are amenable to investment
The UN Sustainable Development Goals, as a set of 17 aspirational goals for shaping national and international economic policies with the ultimate goal of ending poverty by 2030, are being used as a framework for impact investing by some investors. All the goals are amenable to investment, as they cover broad themes such as health, hunger, education, clean energy, innovation, climate action, ecosystems, institutions, and more.
“What’s good about high returns that put wealth in the client’s pocket while diminishing the next generation’s resources?”
Millenials and women are two demographics driving impact investing. Millenials increasingly believe that the purpose of business is to create positive impact, rather than to make profits. The current generation of Millenials stands to inherit more wealth than at any time in history. Women are gravitating to this area in financial services, perhaps because we are naturally oriented toward the long-term, expressed not only by concerns about the kind of planet we leave for our children, but also by an investment mentality that views the spectrum of ROI vs. Impact with some flexibility. What’s good about high returns that put wealth in the client’s pocket while diminishing the next generation’s resources?
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