Affirmative Investment Management partnered with South Pole to produce this case study, Assessing Physical Risks of Green Bonds, as part of our continued commitment to pioneering best practice in green bond verification, impact measurement and reporting. This TCFD-algined physical risk assessment tool is forward-looking and examines three forms of green bond issuers’ exposure to physical climate risks under two scenarios: warming of 2°C and of 4°C.
At 79 degrees north, the northernmost permanent human settlement and gateway to the North Pole, Ny-Ålesund is a leading centre for international Arctic scientific research and environmental monitoring—and it used to be an arctic coal mine. The stunning turnaround from a fossil fuel extraction base to leading climate science research site represents an apt analogy for the type of transition we need to make globally to manage the risks associated with climate change.
This autumn, Affirmative Investment Management (AIM) participated in the annual Ny-Ålesund Symposium, which focussed on climate risks and was timed just ahead of the release of the 2018 IPCC report. The 53 delegates of this high-level convention in the High Arctic comprised climate researchers, investors, green bond issuers and policy makers, brought together to discuss how, collectively, the financial system can navigate climate risks.
Changing demographics and climate disasters are putting water infrastructure under increasing pressure: 4.5 billion people globally are without access to adequate sanitation, 2.1 billion lack access to clean drinking water and flood damage to urban property is estimated to cost US$120 billion annually. It is expected that the investment shortfall in water services and sanitation alone will amount to US$1.7 trillion by 2030, with overall financing requirements for water infrastructure forecast to total US$6.7 trillion. However, only 1.5%  of green-labelled bonds finance water assets under a use of proceeds structure, which points to some significant market barriers, as well as missed opportunities for investment.
After Poland issued the first sovereign green bond in 2016, we saw more countries coming to market – France, Fiji, and finally, Nigeria. A close analysis reveals how scale, synergies and sovereigns’ exclusive access to specific sectors can create some unique sustainability benefits. On the flipside, the broad scope of national policies can lessen transparency and proceeds may not be distributed equitably; governmental change is an even more serious impact default risk, as are the governance weaknesses we see in some emerging markets. Transparent impact reporting, cross-party support for national climate agendas and robust regulatory frameworks emerge as critical factors for long-term sustainable returns.
- Recent severe storms and flooding in the Indian subcontinent, China, Caribbean, and US illustrate the devastating impact that natural catastrophes have on people and economies. As it becomes increasingly clear that we may be locked into at least a 2.0°C warming scenario, it is essential that we turn more of our attention to helping our communities adapt to the effects of climate extremes.
- While many are aware 2.0°C warming will increase the frequency and ferocity of tropical storms, cause sea levels to rise by several meters, crop yields to deteriorate, and is expected to drive the migration of millions of people,[i] adaptation remains critically underfunded.
- We use our SPECTRUM Bond® criteria to review both bond issuer and issuance of labelled green bonds and non-labelled impact aligned bonds. We actively engage with issuers to understand the objectives of the projects and use of proceeds and that sufficient transparency will be provided to enable us to monitor and report to our investors their impact.
- Based on our 2016 average holdings in the US$ Impact Enhanced Cash fund, direct adaptation projects received 12% of the proceeds, combined mitigation and adaptation projects 10%, and pure mitigation projects 78%.
- While mitigation considerations may continue to receive the lion’s share of attention within green bond funding, we believe it is just as imperative that adaptation financing grows in parallel.
Since the Agricultural Bank of China (ABC) became the first Chinese institution to issue a Renminbi-denominated Green Bond in October 2015, China's green bond market has exploded. China was the largest country of issue in 2016, as of October 2016, and propelled by strong government support for green finance, the market is estimated to grow to USD 230bn within the next five years (Bloomberg).
However there are concerns on creditworthiness and differences between China's green standards and those adopted internationally.
Learn more about this growing market, the Chinese green bond regulatory environment, the growing market and developments in the AIM China's Green Bond Market Report.