COP27: Finance Day round-up

There have been some promising announcements on climate finance during Finance Day at COP27. It suggests that momentum may be building to unlock the inertia which exists in the effort to fund the climate resilience of vulnerable countries and enable the global transition to clean energy.

The UK export finance agency, UK Export Finance ("UKEF"), will become the first export credit agency to offer “climate resilient debt clauses” in its loan agreements. In part, these clauses will allow low-income countries to defer debt payments in the event they are hit by a climate disaster. It is an example of the tangible impact that considered adjustments to the international financial system can have; providing flexibility within lending structures to allow borrowing countries to focus on recovering from a climate shock in the short term. The small but growing number of governments (predominantly European) which have announced “loss and damage” funds is another significant step. China has also confirmed that it would be willing to contribute to a mechanism for compensating poorer countries for losses and damage caused by climate change.

The promises and declarations made at COP27 Finance Day are an indication that traditionally complex and protracted policy change mechanisms might be capable of keeping up with the pace required to facilitate the energy transition within required timeframes. This, along with the evident pace of change on the ground and in the real economy (for example, the high number of electric vehicles now on European roads), demonstrates that the goals of the Paris Agreement, in particular limiting the global rise in temperature to “well below” 2°C and achieving net zero by 2050, are still achievable, just. While much of the discussion has understandably focussed on government-led solutions, private capital has a critical role to play in achieving these goals and in the short-term, keeping them within reach.

Many major banks and asset managers are attending COP27 with senior delegations rather than high profile CEOs as they did in Glasgow. This is not necessarily to be read as a reflection of the commitment or capacity of private finance in efforts to “green” the economy. COPs which elicit headline grabbing pledges, such as the commitments in Glasgow from thousands of businesses and financial leaders to align their operations with the Paris goals, are often followed by COPs focused on the implementation of those promises.

In advance of the conference, COP26 President Alok Sharma urged countries to revisit their 2030 emissions reductions targets and strengthen them with workable plans. Scaling up and providing timely access to finance as well as ensuring that finance is flowing to projects and assets which meaningfully and measurably mitigate the effects of climate change is a crucial part of the plan. Deployment of private capital directly in climate finance does, however, remain stunted. The recently published report from the Glasgow Financial Alliance to Net Zero (“GFANZ”) setting out actions to mobilise capital to emerging markets and developing economies states, “by the end of the decade an additional US$ 1 trillion per annum will be required for clean energy investment in emerging markets and developing economies states alone to put the world on track to reach net zero by 2050”.

While there is anecdotally incredibly strong support for the deployment of green finance products among individuals within leading private lending institutions, it appears that many institutions are waiting for further clarity and change in government policies to better support and promote sustainable investment and climate finance. They are also looking to international financial institutions to help unlock investment opportunities into projects which support a just transition to economies with clean, affordable and accessible energy. The publication on COP27 Finance Day of the UN’s list of projects worth USD120 billion awaiting investment is intended to facilitate funders’ assessment of and shore up confidence in a pipeline of meaningful opportunities.

In the meantime, the rise of ESG reporting and disclosure regulation over recent years has without doubt brought environmental considerations (the “E” of ESG) into both the commercial thinking and everyday lexicon of commercial banking and debt markets.

There is ever increasing structure and clarity around this, recently represented by the UK's Financial Conduct Authority’s long-awaited consultation paper CP22/20 on sustainability disclosure requirements regime and accompanying investment labels (read more here). Reputational as much as regulatory pressure has a profound influence. Again, there is more work to do, particularly in terms of making the structure of “green loans” significantly more robust.

A typical “green loan” requires borrowers to utilise funding for specified “green” purposes and to meet certain reporting obligations. Green loan products also typically prevent borrowers and lenders from publicising their loan as “green” where the specified green purposes and targets are not met. However, there’s ordinarily no direct economic penalty for failure, nor usually a risk of lenders looking for repayment or to call a default, although this will of course be negotiated on a deal by deal basis. Further, green loans, as distinct from some other ESG focussed financial products (including sustainability linked loans), do not involve a margin rachet which flexes to reflect poor or exceptional performance.

Green loans, while becoming less of a rarity, remain relatively few and far between within the high-value energy and infrastructure funding market. We expect this to change over time - funding of renewable energy infrastructure, electric vehicle, battery and gigafactory projects, together with a range of telecommunications infrastructure, can be inherently green and present obvious lending cases in an environment where the “green” framework for green loans becomes materially more robust.

The question remains, though, how much impact does the ability to label a loan “green” have in helping to achieve a green and just transition on the path to net zero? With recent focus on greenwashing and the tension between various leading financial institutions and networks such as GFANZ (which previously off-sided some of its members by being too prescriptive about how to achieve net zero) many remain hesitant to take documentary provisions further, for now. The path to increasing use of green and sustainable funding in the energy and infrastructure sphere will require a combination of policy, regulatory and private finance alignment and action. It is hoped that the momentum from COP27 can be leveraged so that project developers, governments and private finance can, together, turn opportunities into results.

In other developments on COP27 Finance Day:

• The US government has announced a new voluntary carbon trading market scheme, dubbed the Energy Transition Accelerator, with a view to boosting investment in renewables projects in development markets. It has received a mixed reaction. Criticism from experts in carbon markets centres around a lack of safeguards needed to prevent the scheme being used to back projects which lead to minimal carbon emissions reductions.
• A group of 85 African insurers has pledged to create a financing facility to provide USD14 billion to help the continent’s most vulnerable communities address climate disaster risks.

See our COP27 page for more coverage of this year's summit and to join us for a post-COP webinar on 22 November.