This blog was authored by Michael Giovanniello and Kai Duan.
@Corentin Le Leannec on Unsplash
This July, torrential rain caused unprecedented flooding in Germany, Belgium, and the Netherlands, as well as China’s Henan province. The resulting disruption to people’s lives and economic activity reminds us of the grave threat that climate change presents to human prosperity and development and underscores the importance of strengthening climate risk management.
As climate change intensifies, less-developed regions stand to suffer the worst impacts, while having the least ability to address them. Countries in the Belt and Road Initiative (BRI) are no exception. On one hand, many BRI countries are at lower stages of development and are both more vulnerable to extreme climate disasters and have fewer resources to mitigate and recover from them. On the other hand, these countries are often rapidly developing and will likely become key drivers of new carbon emissions worldwide, if they do not make a timely transition to low-carbon development patterns.
Although President Xi’s recent announcement that China will no longer build overseas coal power plants and that it will support developing countries to develop green and low-carbon energy makes clear the direction of China’s future overseas development efforts, efforts are still needed to guarantee the sustainability of existing and future BRI investments. Between 2013 and December 2020, China invested $770 billion in projects across 138 BRI countries (Green BRI). Given the scale of investment and the outsized challenges that climate change poses to BRI regions, there is a clear need for robust climate risk management. But how exactly do climate impacts translate to financial risk in BRI countries? And how can climate risk management be improved to promote green BRI development?
New research by NRDC, the Tsinghua University Center for Finance and Development, and the National Center for Climate Change Strategy and International Cooperation advances the discussion on BRI climate risk management. The report “Enhancing Climate Risk Management of Financial Institutions in Belt and Road Investments,” released in August, identifies the key risks that climate change poses to BRI investments and provides recommendations for governments and financial institutions to improve their climate risk management practices.
The report analyzes two forms of climate risks that threaten the financial sector: physical risk and transition risk. Physical risks are those caused by the increased severity of climate events, such as extreme weather, and those caused by changes in ecosystem balance, such as sea level rise or soil degradation, that threaten the material assets of companies; the possibility of major ecological imbalances creates uncertainty for the long-term health of important industries that rely on natural resources, such as forestry and agriculture.
Transition risks arise from society’s efforts to address climate change, such as changes in public policy, technological innovation, investor sentiment, and disruptive business model innovation. To understand how these transition risk factors might impact BRI investments, researchers conducted financial stress tests on selected carbon-intensive sectors under different transition scenarios. As society’s climate ambitions increase, the financial indicators of tested companies— including solvency, liquidity, and profitability — deteriorate, and corporate valuations and profits decline.
The report found that pollution-intensive industries are most at risk. An in-depth case study on Pakistan’s coal power sector illustrates the ways in which fossil fuel industries will be impacted by a transition to low-carbon development. For a representative coal power company in Pakistan, researchers found that with changes brought on by stronger climate policy, such as a decrease in coal power demand, increasing carbon prices, more competitive renewables, and increasing financing costs, etc., the probability of defaulting on coal power loans rises astronomically, from 1% in 2020 to ~35% by 2030. Failure to account for these risks could result in serious losses for the institutions involved in financing these companies and projects.
At the report release event, NRDC invited representatives from Export-Import Bank of China (EIBC), Industrial and Commercial Bank of China (ICBC), and the Asian Infrastructure Investment Bank (AIIB) to share their perspectives on the report findings. These financial institutions discussed their views on the importance of environmental and climate risk management, and their plans to incorporate risk management into their financing practices.
EIBC and ICBC have started to incorporate climate risks into their green credit policy and credit evaluation system. EIBC has formed a sustainability strategy group led by the bank’s CEO and senior management board, which is to coordinate the establishment of the bank’s green investment and risk management policies.
ICBC was the first Chinese bank to join the Task Force on Climate-Related Financial Disclosures and was an original signatory of the “Principles for Responsible Banking.” It has also included environmental and low-carbon performance as key factors in its green investment and credit classification and routine loan evaluation process. In May, the bank’s chief economist announced that it would develop a roadmap and timeline for gradually phasing out its coal investments.
AIIB has an environmental and social policy framework which guides the sustainability of the bank and the projects it finances, with a goal of increasing climate finance to account for 50% of approved financing by 2025. This year, AIIB also announced it will not support any coal-related investment activities and that it will evaluate the climate impacts and risk management measures of projects in their environmental and social impact assessments and due diligence procedures.
These early steps show growing efforts by major financial institutions to improve climate risk management, but there is still a long road ahead for developing and implementing best practices. NRDC and its research partners recommend that financial institutions develop scientific and tailored green investment and risk management strategies for individual countries, by assessing their unique economic and industrial structures. At the same time, China and BRI host country governments, working together with financial institutions, should take measures to improve the data and analytical tools available for management of climate risks. Taking these steps will help lay the foundation for more robust climate risk management and greener BRI development.
