Insight

Basing investment decisions on climate adaptation and resilience impact

As investors become increasingly aware of the implications of our changing climate, there is a growing need for more information about the positive adaptation & resilience impacts of investments.

Private investors are increasingly aware of emerging investment opportunities in adaptation & resilience, with the Bank of America forecasting that the global market for adaptation & resilience may reach USD 2 trillion by the middle of this decade, and MSCI estimating that 11% of publicly listed companies deliver products and services that contribute towards adaptation & resilience.

Information about the positive adaptation & resilience impacts of investments can help to engage private investors and mobilise finance for urgently needed investments in adaptation & resilience.

But private investment in adaptation & resilience is held back by a lack of clear, practical and investor-relevant adaptation & resilience metrics that investors can use to identify, appraise and prioritise investments that make meaningful contributions towards adaptation & resilience​.

Therefore Cadlas is pleased to have worked with the Adaptation & Resilience Investors Collaborative (ARIC) and the United Nations Environment Programme Finance Initiative (UNEP-FI) to develop guidance for investors on the assessment of adaptation and resilience impact in private investments. This guidance, which is available here, sets out a practical framework for assessing adaptation and resilience impact across a broad range of investments using a set of clear, consistent and investor-relevant metrics.

Assessing adaptation & resilience impact in private investments: new guidance for investors

Cadlas is pleased to have provided technical support to the Adaptation & Resilience Investors Collaborative (ARIC) for the development of a framework for assessing the positive impact of private investments towards climate adaptation and climate resilience goals.

This leverages the experience of impact investing to set out a clear framework to help investors measure and manage the way that their investments contribute towards adaptation and resilience.

As private investors become more aware of the scope for investment in adaptation & resilience interventions and solutions, there is an increasing need for meaningful and consistent information about the positive contributions of those investments towards the climate resilience of people, the planet and the economy.

For further details, read the full report which is available on the ARIC webpage: Adaptation & Resilience Impact: A measurement framework for investors

Measuring impact for scaling up investment in climate resilience

Investors need clear, consistent and comparable information about the impact of their investments in order to allocate capital towards effective climate resilience responses and solutions. Cadlas is pleased to be working with the Adaptation and Resilience Investor Collaborative (ARIC) and the United Nations Environment Programme Finance Initiative (UNEP-FI) in an important initiative to advance the measurement of climate resilience impact.

Further details available here.

Cadlas collaborates with Climate Bonds on the Development of a Climate Resilience Taxonomy for Sustainable Bonds

As the impacts of climate change become more evident and increasingly material for governments and companies alike, the need to identify and scale up sources of finance for investment in climate resilience becomes ever more pressing.

Green, social, sustainable and sustainability-linked (GSS+) bonds offer huge potential for accessing capital markets for scaling up urgently needed investment in climate resilience. The USD 3.7 trillion GSS+ debt market enables projects and entities such as corporates, sovereign and sub-sovereigns to access finance for sustainable investments in support of the low-carbon transition, social objectives or other sustainability themes – including climate resilience.

Climate resilience already features in GSS+ bonds, with 19% of GSS+ debt instruments having some degree of climate resilience UoP. Recent examples of issuances covering climate resilience include New Zealand’s sovereign green bond and the Arizona Industrial Development Authority’s sustainability-linked bond. In addition, dedicated climate resilience (or climate adaptation) bonds have been issued by the EBRD (2019) and the AIIB (2023).

However, in order to realise the potential of GSS+ debt instruments for financing climate resilience, a clear and systematic framework for issuers and investors is required. This is why Cadlas is pleased to have supported Climate Bonds on the first phase of the development of their Climate Resilience Taxonomy for sustainable bonds. The Climate Bonds Climate Resilience Taxonomy White Paper sets out a clear, upstream framework for defining climate resilience investments that may be eligible for GSS+ bond issuances oriented towards climate resilience.

The White Paper identifies seven ‘climate resilience themes’, covering resilient agri-food systems, resilient cities, resilient health, resilient industry and commerce, resilience infrastructure, resilient nature and biodiversity, and resilient societies. Across those themes, investments may be categorised according to the level of assessment that they require – enabling those investments with clear climate resilience benefits and low risk of significant harm to other sustainability objectives to move ahead more quickly.

Establishing a common language for issuers, investors and other stakeholders to use will be instrumental for harnessing the potential of GSS+ debt instruments for financing climate resilience. The White Paper lays out a solid foundation for the further development of this work over the next few years.

Climate resilience and sustainable finance: will Cinderella go to the ball?

Climate resilience – or adaptation – has been referred to as the Cinderella of climate action. Is it time for her to go to the sustainable finance ball?

We’ve seen important progress in the mainstreaming of physical climate risk information into financial decision-making over recent years. In 2017, the TCFD recommendations created space for information about physical climate risks – and also related opportunities – in climate-related financial disclosures. This was advanced further through the 2021 TCFD guidance on metrics, targets and transition plans, and has now been mainstreamed into the 2022 ISSB draft guidance on climate-related disclosures. As a result, there is now more information available about how financial and non-financial firms are affected by physical climate risks, with the TCFD’s 2022 Status Report finding that 21% of asset managers and 36% of asset owners were reporting their exposure to physical climate risk. Ratings agencies have internalised physical climate risk information into their credit rating methodologies, and a range of service providers and open-source platforms on physical climate risk information have emerged. Furthermore, financial supervisors in a number of jurisdictions have integrated physical climate information into their supervisory requirements on climate-related risk disclosure, for example the ECB, the Bank of England, as well as international bodies such as the NGFS and the Basel Committee on Banking Supervision.

This is good news for market action on climate resilience – also referred to as adaptation. Robust information on physical climate risks is the foundation stone for managing those risks, and for building resilience to them. But there is a kind of asymmetry in the information flows available to investors at present. Investors are now getting some information on reasons not to invest because of exposure to physical climate risks but are getting much less information on reasons to invest because of the potential to contribute positively towards building climate resilience. In fact, more information about physical climate risks in the absence of complementary information about the positive contributions of investments towards climate resilience could even drive finance away from where it is most needed. This is sometimes referred to as capital flight – raising the cost or capital for climate-vulnerable sectors or countries, for example small island developing countries. This contradicts the need for significantly scaled-up investment in climate resilience investment, which the United Nations estimate as up to USD 340 billion per year by 2030.

Regulatory frameworks for sustainable finance have evolved significantly in recent years – but what potential is there for these to facilitate greater investment in climate resilience? To date, sustainable finance has focused principally on decarbonisation, based on the logic that capital should be driven towards addressing the root cause of climate change by reducing GHG emissions. But the emerging sustainable finance architecture also has the potential to address the other climate change imperative – the need to cope with the inevitable impacts of climate change. These will be significant even under a 1.5^oC scenario, with the European Environment Agency estimating adaptation finance needs of EUR 40 billion per year under a 1.5^oC scenario in Europe alone. Climate resilience features prominently in the EU Sustainable Finance Taxonomy, which identifies adaptation as one of its six sustainability objectives. However, the role of climate resilience in the application of the EU Taxonomy appears to be limited to a do no significant harm function only. There is very little evidence of sustainable finance being defined on the basis of a substantial contribution to adaptation. In fact, the EU’s Platform on Sustainable Finance has recently pointed out that urgently needed adaptation investments may be disincentivised by the way that the Taxonomy requires users to select one sustainability objective only, which is usually mitigation due to the overwhelming market interest in decarbonisation. Other building blocks of the EU sustainable finance approach, such as the Sustainable Finance Disclosure Regulation (SFDR) and the Corporate Sustainability Reporting Directive (CSDR), fail to provide clear entry points for climate resilience as a basis for defining sustainable finance or reporting corporate action on sustainability.

So what are the ways in which the momentum on sustainable finance can also advance urgently needed action on climate resilience?

Firstly, recognise that climate resilience and decarbonisation objectives are not in opposition to each other, but can be and should be aligned. Advancing climate resilience does not mean diluting ambition to stay under 1.5^oC. Significant investment in climate resilience will be needed even under a 1.5^oC scenario, but the more that we overshoot 1.5^oC, the greater still those climate resilience investment needs will be.

Secondly, make space for climate resilience in sustainable finance definitions and labels. Investments that make meaningful contributions towards addressing physical climate risks and building the resilience of people, nature or the wider economy should be able to be identified as sustainable investments – with clear safeguards in place to eliminate greenwashing and ensure that other sustainability objectives, including decarbonisation, are respected. For instance, it will be interesting to see whether climate resilience will be considered under the sustainable impact label that is being considered under the UK’s proposed Sustainability Disclosure Requirements.

Thirdly, develop and build consensus around clear, understandable, and consistent impact metrics that investors can use to assess the contribution that investments make towards climate resilience. Together with the rapidly expanding availability of physical climate risk information, these could help to inform capital allocation that supports climate resilience goals. These metrics should be developed with clear reference to the evolving regulatory context for sustainable finance, to ensure relevance and usefulness for as wide a range of investors as possible.

Climate resilience is sometimes referred to as the Cinderella of climate finance – dutifully clearing up in the background, while her louder and pushier sisters hog the limelight. But with climate change impacts already affecting the lives of millions, and the need for scaled up investment in climate resilience no longer a distant prospect, it’s an issue that can no longer be sidelined in the sustainable finance discussion. It’s time for Cinderella to go to the ball.

There is reason to be hopeful of a significant scaling up of sustainability-related information flows over the years ahead, with the development, adoption and harmonisation of a number of sustainability disclosure frameworks. This includes, not least, the emerging ISSB standards on climate and sustainability, while the EU sustainability disclosure regime also continues to advance, and in the USA the SEC has released for consultation a proposed climate disclosure rule. A number of national jurisdictions (France, Japan, New Zealand and the UK) have already introduced mandatory TCFD disclosure requirements, with the entire G7 expected to follow their lead in the coming years.

At the same time, the physical climate change impacts continue to rise up the agenda. The IPPC paints a sombre picture of accelerating global heating, while the WEF has identified global climate action failure and extreme weather as the two most severe global risks over the next decade. In June this year, UN climate talks in Bonn ended in acrimony, with clashes over climate finance flows driven by the concerns of vulnerable countries facing severe physical climate risks.

So, how is physical climate featuring in these fast-evolving sustainability disclosure frameworks? Is it still the poor cousin to carbon-related disclosures, or is it beginning to catch up? Cadlas takes a closer look

The story so far

There has been some progress over recent years, driven largely by the continued evolution of TCFD recommendations. While physical climate has always been part of the TCFD framework, its prominence was limited at first. However, things quickly advanced in the years following the TCFD’s launch in 2017. This included the emergence of physical climate analytics service providers, and a number of initiatives by organisations including the EBRD and the Global Centre on Adaptation, and UNEP-FI.

As climate risk become mainstreamed into financial supervision, physical climate assumed a central role alongside carbon transition. This was evident in the comprehensive climate-related requirements of prominent supervisors such as the Bank of England, Banque de France and the European Central Bank, as well as influential international bodies such as the NGFS and the Basel Committee on Banking Supervision.

An important step forward occurred in 2021, when the TCFD updated its guidance on metrics and targets. This has influenced the inclusion of physical climate in other disclosure frameworks such as the ISSB, EFRAG and SEC, and climate disclosure regimes in the UK and elsewhere that follow TCFD recommendations.

Key common features

So how is physical climate is being treated in the main sustainability disclosure frameworks?

One general theme is that they all call for physical climate to be mainstreamed across climate-related disclosures, typically following the TCFD structure of governance, strategy, risk management and metrics & targets. In practice though, physical climate is often overshadowed by carbon transition and suffers from a lack of guidance on precisely how it should be assessed and disclosed. In line with the direction set by the TCFD, three broad categories of disclosures, which are either directly or indirectly related to physical climate, are emerging as broadly common across all the main frameworks.

Exposure to physical climate risks: this refers to extent to which business operations (assets, revenues, turnover or other activities) are exposed to material physical climate risks. However, there is significant room for interpretation in the scope, boundaries and granularity of physical climate risk assessments, the climate models, scenarios and timescales used, the definitions of physical climate hazards used, and the criteria used to assess the materiality of physical climate risks.

Alignment with climate resilience opportunities: while the cross-industry TCFD metrics refer to climate-related opportunities in general, this clearly includes opportunities associated with climate resilience (or adaptation), for instance an agricultural company’s revenues from the sale of drought-resilient seeds. This calls for clear and widely understood definitions of climate resilience opportunities. Relevant taxonomies such as the EU Taxonomy may help to provide this necessary clarity, although it may take time for the necessary market familiarity with its adaptation requirements to evolve.

Capital deployment associated with physical climate: again, the cross-industry TCFD metrics refer to capital deployment towards climate-related risks and opportunities in general, and once more this also clearly covers physical climate. This could include, for example, capital deployed for making infrastructure more resilient, or towards investment in efficient irrigation or weather monitoring technologies. Such disclosures may provide incentives for organisations to report private adaptation finance flows, thereby filling a significant information gap in the climate finance landscape.

Application across different sustainability disclosure regimes

While the overall direction of travel may be broadly consistent, there are some differences in the approaches being taken by the various emerging sustainability disclosure regimes.

The draft ISSB climate standard is closely aligned with the updated TCFD requirements and mirrors its cross-industry metrics on physical climate risk exposure, alignment with (physical) climate opportunities and capital deployment for (physical) climate-related risks and opportunities. At the industry-specific level, the draft ISSB climate standard refers directly to the SASB industry standards, although only some of these cover exposure to physical climate risk (e.g. agricultural products).

Within the evolving EU sustainability disclosure regime, the existing non-binding guidelines on climate-related reporting follow a roughly similar pattern to the TCFD, calling for information on exposed to physical climate risk, and on the percentage of turnover and of investment or expenditures that qualify as climate resilience opportunities by meeting the criteria for Substantial Contribution (to adaptation) under the EU Taxonomy. However, these will soon be superseded by EFRAG’s draft climate change standard, currently under development. This sets out a more granular approach that, in addition to the above points, also covers policies, targets, plans and resources related to climate (including, presumably, physical climate). This standard will naturally reflect the EU’s commitment to double materiality (i.e. sustainability matters that are both financially material to businesses and material to the market, the environment, and people), although precisely how this concept applies to physical climate requires further consideration and discussion.

Looking forward

It is no longer true to say that physical climate is being left out of climate and sustainability disclosure frameworks, nor that physical climate requirements are completely unambitious – in fact, if the requirements of the above disclosure frameworks on physical climate were to be followed to the letter, then this would be considerably challenging for most organisations, under current conditions. However, there remain important areas whether further advances are still needed:

• More consistent and granular requirements and guidance on physical climate risk assessments, including scope, boundaries and the definition of physical climate hazards, the climate models, scenarios, timescales and materiality criteria used.
• Clear differentiation between carbon transition and physical climate in disclosures of climate-related opportunities, and better application of taxonomies and definitions for climate resilience opportunities.
• Clear differentiation between carbon transition and physical climate in disclosures on climate-related capital deployment, and clear linkages made between capital deployment for climate resilience and adaptation finance tracking.

The absence of any mention of impact metrics in any these frameworks also needs to be addressed. These are needed for expressing how physical climate risks are managed and how climate resilience is advanced, and are also necessary for making adaptation taxonomies fully operational.

Finally, the extent to which any of these disclosure frameworks meaningfully address physical climate will ultimately depend upon the way in which they are applied, monitored and enforced by regulatory or supervisory authorities. If they choose to pay due attention to physical climate in sustainability disclosures, then this could play an important role in helping markets adjust to the reality of a changing climate, and to contribute towards building more climate-resilient economies.