The coronavirus crisis is severely testing the resilience of Latin America and the Caribbean economies and health care systems. At the same time, LAC is extremely vulnerable to climate risks and disasters such as floods, the spread of disease and loss of infrastructure.
Governments’ fiscal space is currently being squeezed considerably following weak economic growth combined with the oil market crash, steep fall in remittances and tourism and weak commodity prices. Given these budgetary pressures on governments, mobilizing private sector finance will be critical to support the economic recovery.
Cometh the hour of green bonds?
Green bonds could be an important instrument to mobilize financial resources to support an economic recovery aligned with building net-zero emission and climate resilient economies.
In 2019, green bonds progressed impressively in LAC reaching roughly USD 14 billion in issuance. However, to date only 3-5% of the proceeds of green bonds are channeled towards climate adaptation and resilience investments globally. This is due to a lack of awareness on the benefits of investing in resilience, of common methodologies on how to assess climate risk and of definitions and taxonomies.
To discuss these issues, the IDB’s Climate Change Division organized a webinar on Building Resilience through Green Bonds. This follows the launch of Climate Bonds Initiative’s Climate Resilience Principles (CRP) and the European Bank for Reconstruction and Development’s (EBRD) first dedicated climate resilience bond, which raised USD 700 million in 2019 to finance existing and new climate resilience projects.
What counts as “investment in resilience”?
Under the Climate Resilience Principles, resilience investments are those that improve the ability of assets to persist, adapt and/or transform to reduce risk, avoid maladaptation, unlock development and create benefits.
Climate resilience investments can be either asset focused (climate resilient crops or upgrading existing infrastructure) where the intention is to maintain or enhance the resilience of an asset or activity to climate change. This may contribute to providing climate resilience benefits to the system in which the asset or activity is a part, depending on the type of product or service the asset or activity provides.
They can also be system focused (e.g. flood defense, mangrove conservation or green roofs) where the intention is to deliver climate resilience benefits to the broader system, going beyond merely ensuring an asset’s or activity’s performance over its lifespan.
Bond issuers also need to assess climate risk and implement measures to reduce them to a manageable level.
The overall objective is to have assets that are ‘fit for purpose’, will continue providing services/ benefits despite climate change while not harming the system where they are located. For example, if climate resilient crops are used, we need to make sure that there will be no overall loss of productivity of the agricultural unit or farm.
The Climate Resilience Principles could be summarized as follows:
- Focus on physical climate risks (e.g. more intense hurricanes, flooding and droughts)
- Generic and are applicable to all assets/projects/activities
- Applicable over the operational life of assets, understanding and addressing future and uncertain criteria
- Qualitative and process-based since responses to climatic conditions and shocks are context specific
- Consider possible trade-offs between emitting and resilient activities
- Require regular monitoring and reappraisal
The first EBRD Climate Resilience Bond
In 2019, the EBRD introduced Climate Resilience Bonds under its existing Green Bond Portfolio and issued a USD 700 million bond to finance a portfolio of activities aligned with the CRP, and in compliance with EBRD environmental and social policies.
Currently, most of the portfolio is related to climate resilient infrastructure projects but the EBRD framework allows for the inclusion of climate resilient business and commercial operations, and climate resilient agriculture and ecological systems.
For instance, an investment project in Moroccan irrigation infrastructure takes place in a water stressed region. The project is a Public-Private Partnership that provides technical and institutional capacity development and encourages local community participation and scales-up additional private sector involvement.
On the other hand, the rehabilitation and upgrade of a Tajikistan hydropower plant will increase its capacity and strengthen projected climate change related impacts and will include dedicated technical assistance and capacity building.
Both projects address specific physical climate risks and enable more efficient practices that deliver multiple benefits. The bond was very well received, with interest from asset managers, central and commercial banks and insurance and pension funds.
The Climate Resilient Principles represent a very valuable starting point to explicitly integrate climate resilience in the green bond market, leveraging existing protocols, template and processes of a still niche but growing market.
The CRP are still under development as there is pending work in developing further sector-specific criteria, detailed standards and definitions to accompany the principles. Ultimately, their applicability will depend on the nature of each sector and the context of each region/country.
Identifying and assessing the benefits of investing in resilience remain among the main challenges to achieve long-term, sustainable assets. In particular, the lack of specific and readily available metrics to capture climate risks makes it difficult for the pricing of resilient improvements on the long-term risk profile of the investments.
The CRP also represents a way to align capital markets to the wider transition of the financial sector towards better assessment and management of climate-related risks and opportunities, being driven by the Task-Force for Climate Related Disclosures (TCFD) and the Central Banks Network for Greening the Financial System (NGFS).
Advancements in the regulatory and supervisory settings, as well as increased investors’ awareness of portfolios’ exposure to climate risk, will improve the environment to issue climate resilience bonds. It is also important for interested issuers in LAC including sovereigns, cities and states, public and private financial actors to identify pipelines of suitable projects and sound processes to present to investors “fit-for-purpose” climate resilient investments.
As LAC countries design economic recovery plans, the IDB is committed to supporting its partners to explore these opportunities, learning from existing projects financed through climate resilience bonds, and explore piloting new instruments and structures.