The effects of climate change started to be felt more and more every day and now it become the focus of the financial sector. Since 1850, global temperature has risen approximately 0.83˚C in the world, but it is estimated that this increase will exceed 4˚C if the necessary actions is not taken by the end of this century. Climate change, with increasing average temperatures, leads to an increase in extreme weather events and natural disasters. This situation creates social and economic damages.
2011 was the year in which natural disasters caused the greatest economic damage in the world history, amounting to 486 billion US dollars. 2017 caused the second most damage by natural disasters, amounting to 340 billion US dollars. Insurers had to pay a record amount of 138 billion US dollars. 83% of the damage was experienced in North America because of hurricanes, while the causes of these damages observed as multi-dimensional. For example, the 20 cm rise in the sea level on the Manhattan caused 30% more insurance losses in New York than the Hurricane Sandy in 2012. In Europe, weather conditions caused 3.6 billion-US-dollars damage in agricultural production while drought and fires caused 3.8 billion-US-dollars damage.
Climate change affects our lives in every aspect from our security to our agricultural production. As a result, the world is forced to enter a period in which the future of investments becomes uncertain and risks are increasing day by day. Looking at past trends is no longer sufficient, and we are in a period that we have to try to predict the future.
Sustainable finance can be an important tool in managing climate change related risks
Businesses have important responsibilities in order to challenge the climate change and to manage and minimize the risks arising from it.
Shifting to a low-carbon economy brings various investment requirements with it and managing climate risks correctly is now critical. For example, in order to keep the increase in temperature below 2˚C the energy sector solely is expected to need investments between 190 and 900 billion US dollars annually by 2050. For this to happen, sustainable finance is accepted as a fundamental tool for managing or preventing the increase of climate change related risks.
So, what does this mean exactly? Sustainable finance includes all kinds of financial services in which risks are analyzed in detail; that considers environmental, social and governance criteria. Such financial services are expected to create long-term benefits to the society. As investors become more aware of the issue, these new financial services are becoming more diversified. According to a research conducted by MIT Sloan Management Review, for more than 70% of investors, sustainability plays a central role in their investment preferences.
One of the first examples of sustainable finance solutions is the Climate Awareness Bond, the first green bond issued by the European Investment Bank in 2007. The green bond market, which has grown rapidly since the first issuance, reached a volume of more than 160 billion US dollars in 2018. The sustainability bond market is expected to grow further in the upcoming period. Market also includes bonds with high social impacts, referred as the “social bonds”.
As the number of natural disasters such as droughts, floods and hurricanes increase, great economic losses occur. Climate change related devaluation of assets creates an important problem for the investors and the financial sector. A major role falls on the financial sector to minimize business losses and encourage business to integrate sustainability into their preferences to support businesses in their fight against climate change.
In the future of sustainable financing, it is critical to create a common ground and common frameworks. In the action plan for financing sustainable growth published by the European Commission in 2018, the first prominent item is taxonomy in green financing. The classification is intended to provide a framework for sustainable investments. Having a framework to classify the sustainability of investments in environmental terms will create a stronger green financing market in the long run.