FINANCING FOR CLIMATE RESILIENCE FOREWORD This year’s G20 Summit in Germany concluded green finance is key to addressing a range of global challenges with strong, sustainable and resilient economic growth. As we cross the two-year mark since the signing of the 2015 Paris Climate Agreement, the ability to finance climate resilience and sustainable growth has become an urgent mandate for organizations and governments. With global sustainable investment growing at a double-digit rate, investors are grappling with the urgency of the situation and the attractiveness of the opportunities, as green financing creates new markets to penetrate and consumer bases to attract. It is clear however, that financing climate resilience will require significantly more capital investment, greater collaboration between the public and private sectors, sound policy, and innovations in finance and risk management practices, both at an enterprise and economy level. We are pleased to provide this collection of insights from across our organization on how to address the factors inhibiting climate resilience financing. A companion report with further insights on strategies for climate resilience and climate risk management will be released in January 2018. Jane Ambachtsheer John Colas Partner Partner Mercer Oliver Wyman Copyright © 2017 Marsh & McLennan Companies i TABLE OF CONTENTS STRATEGIES 4 A STRESSING CLIMATE? 21 FINANCING A GREEN FUTURE Key Challenges for Banks in Assessing and Disclosing Who is driving it past the tipping point? Climate Change Risk Jaclyn Yeo Jane Ambachtsheer, John Colas, Ilya Khaykin and Alban Pyanet 25 INCREASING CLIMATE RESILIENCE THROUGH RISK FINANCING 8 FINANCING CLIMATE RESILIENCE Case Study Mozambique Practical considerations to enhance structures in Thomas London and Robert Wykoff place today Peter Reynolds and Gaurav Kwatra 30 PATH TO SUSTAINABLE INFRASTRUCTURE 13 HOW BONDS CAN CLOSE THE CLIMATE Amal-Lee Amin and Jane Ambachtsheer ADAPTATION FINANCING DEFICIT Alex Bernhardt 16 RISK FINANCING Closing the Gap in Flood Protection Charles Whitmore Copyright © 2017 Marsh & McLennan Companies ii FINANCING A STRESSING CLIMATE? KEY CHALLENGES FOR BANKS IN ASSESSING AND DISCLOSING CLIMATE CHANGE RISK JANE AMBACHTSHEER, JOHN COLAS, ILYA KHAYKIN AND ALBAN PYANET Copyright © 2017 Marsh & McLennan Companies 1 NEW RECOMMENDATIONS SCENARIO ANALYSIS TO FOR FINANCIAL DISCLOSURE ASSESS CLIMATE RISKS AND OPPORTUNITIES Companies in all sectors, including those in the financial-services industry, are being asked In adopting the TCFD recommendations, the same question: What are the implications financial institutions will need to embed the of climate change risks and opportunities for impact of climate change into their strategy, your organization’s financial performance? risk, and opportunity analyses. These Investors, regulators, consumers, suppliers, analyses should consider the physical risks and employees are looking for greater clarity stemming from climate change in the physical and transparency on this issue. At this stage, environment, the transition risks associated however, there’s no established best practice with the economic costs of moving to a lower- for assessing the impact of climate change on carbon economy, and the opportunities bank performance. This topic has not escaped for developing new products and services the focus of central bankers, specifically in response to climate change. The TCFD Financial Stability Board (FSB) Chair and Bank recommends using scenario analysis to support of England Governor Mark Carney, who has this exercise – including the consideration of a written and spoken extensively on climate 2 degree Celsius (or lower) global temperature- change risk. The recent release of a disclosure warming scenario aligned with the 2015 Paris framework aims to facilitate the process; yet Climate Agreement. companies—particularly financial institutions— face a number of challenges in implementing Scenario analysis is a well-established method the recommendations. to inform strategic plans and ensure resiliency to a range of future states. The use of scenario The FSB Task Force on Climate-related analysis to assess the implications of climate- Financial Disclosures (TCFD), issued a set of related risks and opportunities for companies, recommendations in June 2017, providing a however, is recent.2 framework and approach for all companies to report on climate impacts in their mainstream Organizations need to consider a range of financial filings.1 The disclosures, which are scenarios relevant to their businesses. Alongside meant to be voluntary, consistent, comparable, the Paris Agreement scenario (where a rise reliable, and clear, should aim to provide in global temperatures is limited to 2-degree material information to lenders, insurers, Celsius by 2100 but significant transition risks investors, and other stakeholders. This arise from the economic adjustment needed disclosure of the financial impact of climate- to limit the temperature increase), scenarios related risks will push institutions to enhance with higher degrees of warming are typically how these risks are assessed, priced, and considered to further stress the physical risks managed. To that end, banks and financial of climate change (such as a 3-degree Celsius institutions are particularly encouraged to scenario, which is broadly aligned with the adopt the recommendations. current Paris commitments, and a 4-degree Celsius or warmer scenario that reflects the current temperature pathway if countries do not follow through on their commitments). 1 In late 2015, at the request of G20 leaders, finance ministers, and central bank governors, the Financial Stability Board (FSB) established an industry-led task force under the leadership of Michael Bloomberg. The task force was charged with developing voluntary, consistent climate-related financial risk disclosures for use by companies in providing information to investors, lenders, insurers, and other stakeholders. To learn more, see: https://www.fsb-tcfd.org. 2 Mercer first introduced this approach with its 2011 report, Climate Change Scenarios – Implications and Strategic Asset Allocation, followed by its 2015 study, Investing in a Time of Climate Change. Copyright © 2017 Marsh & McLennan Companies 2 Each scenario must include a set of coherent − If retaining a longer-term view variables and a narrative explaining the (roughly 25 years), forecasting underlying rationale for the values and trends income statement and balance-sheet of the variables, as well as the interdependency views requires modeling anticipated between them. These variables can include changes in the portfolio composition, assumptions on policies and regulatory business models, and financial developments (regionally, domestically, and structure of the institutions. Results internationally), the pace of technological will be subject to multiple assumptions change, the sea level rise, and how these (scenario, portfolio evolution, and disruptions may positively or negatively impact sector evolution), complicating industry sectors and supply chains. Along their interpretation, significantly increasing uncertainty, and decreasing with this, organizations need to develop a comparability between banks. methodology capable of translating scenario variables into a financial impact. A fine balance There are two main implications: is needed to thread the complexity of the processes and analyses so as to ensure realistic − Comprehensive sensitivity testing of implementations and executions of scenario potential credit losses is more relevant planning and assessment. and appropriate at this stage than a full-blown, firm-wide, holistic stress- testing exercise that would cover losses, CHALLENGES IN DEVELOPING revenues, and capital. Such sensitivity EFFECTIVE CLIMATE SCENARIOS testing can help banks assess the exposure under alternative portfolio There are a number of challenges in developing constructs and business strategies and effective climate scenario analyses to support therefore drive decision making. While management in reaching actionable decisions. holistic stress testing may someday be For example, the banking sector faces four useful, at the moment, it introduces key challenges in developing climate scenario greater uncertainty into forecasts analyses for their wholesale exposures. and complicates an interpretation of the results. 1. Time horizon – The disconnect between − Existing models will require adjustment the typical time horizon of risk analyses and and/or new models will be necessary the longer-term climate forecast horizon. to accommodate the longer-term time horizon. Time horizon is a key challenge when modeling the impact of climate change 2. Data availability – Data gaps for assessing on bank performance, as the impacts will climate impacts on credit risk. materialize over a longer time frame than banks typically consider in their processes Banks currently do not have comprehensive, and tools: deal-by-deal climate-risk assessments across the portfolio and often have only − If retaining a short-term view of the very limited relevant climate attributes of climate scenario (such as three-to-five their borrowers. Moreover, in contrast to years, which is similar to stress-testing traditional macroeconomic stress testing or planning horizons), there will be a where a model can be calibrated and back- limited impact, as the biggest impacts tested against previous crises or economic are expected in the medium to long environments,