COP 28: Overcoming risk is key to unlocking climate-nature investment
Transforming the way risk is both perceived and managed will boost institutional capital flows into nature positive projects, investors say
There needs to be a wholesale transformation in the way risk is both perceived and managed to bring more institutional capital into nature positive projects, investors argued at this year's climate conference in Dubai.
Recognising the interconnection between nature and climate was a key theme at COP28, as various high-level talks and side-events looked at ways to build on state-level commitments to nature-based solutions to climate change.
Climate change and biodiversity loss affect livelihoods, and exacerbate the risks of poverty, forced displacement and conflict.
At the same time, conserving and restoring biodiversity and ecosystems are essential for addressing climate change and its impacts. Nature-based Solutions (NbS) play a key role for climate mitigation, adaptation and to address biodiversity loss, and bring additional economic and social benefits, such as health and well-being, according to statements from the EU.
From an institutional investor perspective, the reality of risk considerations often stands in the way of impactful investment decisions.
Pension funds and insurance companies tend to invest conservatively, their preference for stable long-term returns with limited risk fuelled not only by fiduciary duty but also by regulatory requirements.
For example, Basel III and Solvency II obligate banks and insurers to hold regulatory capital against "sub-investment" grade instruments.
“One of the main problems with emerging markets is that the vast majority of the countries and projects have sub-investment grade credit ratings,” said Thomas Tayler, head of climate finance at Aviva Investors. "This creates a massive disincentive for institutional investors.
Multilateral Development Banks and blended finance
One solution to the "risk" conundrum is to reform the role of multilateral development banks and scale up the amount of catalytic capital - money used to "de-risk" investments - available to blended finance vehicles.
To this end, at COP28, a coalition of multilateral development banks published a joint statement where they presented concrete and urgent actions to scale up finance and enhance climate outcomes measurement, strengthen country-level collaboration, and increase co-financing and private sector engagement.
“The window of opportunity to secure a liveable and sustainable future for all is rapidly closing," the MDB statement said. "Recognising the interlinkages between the triple planetary crises of climate, nature, and pollution, achieving the Sustainable Development Goals, the goals of the Paris Agreement and the Kunming-Montreal Global Biodiversity Framework (GBF) requires all of us to step up our efforts with urgency and scale."
If multilateral banks can use their balance sheets and “increased” ambition to bring risky investments up to investment grade, then the ability of private finance to follow in behind them rises dramatically, Taylor said.
That said, the sheer amount of capital required to solve the nature-climate crisis – some $5-7 trillion per year – means private investors can’t solely rely on multilateral banks, “however ambitious they are in terms of their balance sheet”, Taylor added.
“There also has to be other forms of investment, including private capital investing on commercial terms,” he said.
“We need to look across the whole of the financial architecture to make sure that we have a transition focused, transition oriented system, because ultimately, not solving the nature-climate crisis undermines the whole system.”
Changing the perception of risk
One major problem with that "financial architecture" is the siloed, fragmented way of calculating risk.
While many nature-positive climate projects in emerging markets are tagged as “sub-investment” grade, Taylor argued that such investments “help protect the value of developed markets as well”, given that the climate-nature crisis is a global problem, and the investors simply can’t “diversify away from those risks”.
It’s crucial, therefore, that the financial system and its rule-makers focus not only on instrument and country-level risk but also on the impact of the systemic risk of not solving the nature-climate crisis.
Ultimately, that means transforming both the regulatory system and the role of MDBs.
“The problem isn’t a lack of capital, but that the money isn’t going to the right places,” said Diana Acconcia, director of international affairs and climate finance at European Commission.
She added that "risk" calculations are instrumental in driving that poor outcome.
The EU's “European Fund for Sustainable Development Plus” aims to mobilise $300 billion for developing countries for infrastructure and the green and digital transition.
Concrete steps to change the system
Andreas Thermann, environmental finance and partnership specialist at Asian Development Bank (ADB) – one of the signatories of the MDB joint statement – outlined four obstacles to climate and nature investment.
- Limitations to government spending. MDBs should do more to help governments spend more on nature and climate. In addition to providing guarantees and loans, MDBs can help governments work on reducing harmful subsidies in order to free up funds for sustainable development. They can also help them with “innovative” financial instruments, such as debt-for-nature swaps - a potentially useful extra source of funding.
- Regulatory framework and investment environment. Creating an enabling policy environment - a key theme at COP28 - means establishing a price for harming nature and climate. This can be done through measures such as regulation, carbon taxes, ecosystem payments, and tax incentives for nature positive investments. An enabling policy environment will facilitate the “development of bankable projects and scale up financing”.
- Private sector participation. Increasing government spending and improving the regulatory and policy environment will help unlock private sector investment and reduce the burden on governments. With time and education, investors will develop a better understanding of the new investment opportunities. The perceived risks will diminish.
- Just transition. The poorest members of societies are often those most affected by climate change and nature loss. They shouldn't have to pay for the transition. Indonesia, for example, has recently unveiled a training programme to prepare coal miners for green jobs. Similar programmes would look to prevent overfishing and support coastal communities.
Case study: regenerative agriculture
Regenerative agriculture is a great example of a “nature positive” climate development practice. It improves soil, delivers high productivity and high-quality food and helps fight climate change and restore lost biodiversity.
Many of the key practices of regenerative agriculture – intercropping, where multiple crops are planted together, agroforestry, and integrating livestock, for example – work with the land rather than against it.
The global food system is responsible for one third of all GHG emissions and is the biggest single driver of biodiversity loss. Its transformation is critical for solving the nature-climate crisis, as highlighted by COP28’s Food Systems Declaration, which attracted 130 country signatories.
Yet regenerative agriculture is dogged with the kinds of “risk” issues that have held back the large-scale deployment of institutional capital.
Not only does its spirit of innovation generate uncertainties, but also, unlike the energy transition, which is dominated by large players, the many “smallholder” farmers involved in regenerative agriculture increase transaction costs and complexity of deals.
On its quest for innovation, Rabobank has onboarded several thousand smallholder regenerative agriculture farmers and monitors their agroforestry projects via satellite - one way around the "complexity" issues.
“One problem common to both banks and investors is that they view sustainable agriculture as incredibly risky,” said Roland van der Vorst, head of innovation at Rabobank, one of the world’s foremost financiers of agricultural projects. “We have to crack this."