Pricing risk

So how can we get the business sector, the economy’s engine, to do things differently this time? “The mantra of people like myself and FMO is that businesses must lead the way by reducing their emissions. That’s true, but how do they know if they’re doing enough, or moving fast enough?” To help businesses answer this question, think tanks like the World Resources Institute (where Kitty worked from 2014-2019), World Economic Forum (WEF), WWF and others have developed a science-based targets system that allows them to work with an individual business to identify its ‘fair share’ towards the climate solution – defined as a percentage emissions reduction. “This approach is transparent and holds everyone accountable. And being informed by someone outside your organisation how much you actually should do as a business moves us beyond greenwashing. But it can only work if the financial sector plays its part. For example, by adopting the G20’s Task Force on Climate-related Financial Disclosures (TCFD) recommendations, which allow a company’s investors, lenders and others to identify the climate-related risks of any investment, and thus price risk appropriately and avoid macro-economic instability. Development banks like FMO have a big role to play here.”

Crossroads

So having described the fork in the road where we now find ourselves, how optimistic is she that we will take the right path? Kitty laughs, “The science makes me pessimistic, but by nature I’m optimistic. Science has told us for decades that the window is shrinking, and every year we don’t act will mean more drastic measures when we finally do — and we know politicians and the public don’t generally like drastic measures. The Corona crisis shows we can take tough decisions. People just need to acquire the same sense of urgency about climate change.” Again, the optimist in Kitty sees glimmers of hope. “Certain transition targets which in Copenhagen in 2009 seemed almost out of reach have been achieved. For example, the UK recently for the first time generated enough renewable energy not to need any fossil fuels in its energy mix. And we’re seeing signs of decoupling in the US and Europe, but now need to see them in developing economies, too.” Kitty also points to the economic incentives: renewable energy sources are now outcompeting fossil fuel ones, and green solutions now deliver a better ROI than grey or brown ones. China is investing heavily in renewables because it knows they are tomorrow’s markets. “So taking the right path also makes economic sense. We need to accelerate, and the push now needed can be made using the huge public investment package that, ironically, a global pandemic has put on the table. But make no mistake: this is our last chance.”

Public + Private

What is the role of government in driving this acceleration? “We need both the public and private sectors to solve this crisis. Take renewable energy. Some 850 million people worldwide have no access to electricity, and almost 3 billion rely on wood or other biomass for cooking. The private sector has a role in resolving this unacceptable situation by bringing renewable energy to poor people. But these are not markets with which most businesses are familiar. So the role of people like me in the public sector is to de-risk those private sector investments just enough to help companies enter those markets. Then, as that market grows, the public sector should gradually withdraw, until eventually you no longer need public sector subsidies because the energy source has become cost competitive in that market – as is now the case in the West with wind and solar. But as Kitty stresses, giving people access to energy is just the start, as it gives them access to the economy and a chance to create a dignified life for themselves. The same principles apply to other sectors, like improved food systems and water management. So that through a partnership of government, the corporate sector, the financial sector including development banks like FMO, and entrepreneurs we hit the twin goals of the Paris and SDG agendas.

Financials as catalyst

Kitty sees huge scope for the financial sector as a catalyst for change. “Getting those who invest in business to apply the right criteria, and punish the wrong behaviour by pricing risk, is the biggest single change we need to see in the next five years.”

She believes the business sector understands the threat of climate change. She points, for example, to the most recent WEF Global Risk Report, where business leaders rank the five biggest risks to business continuity ten years from now as: failure to address climate change, failure to adapt to climate change, extreme weather events, social unrest through food shortages and water scarcity.

“From having no product because of drought-induced crop failure to literally being unable to bring a product to market due to impassable roads, businesses understand these interconnected risks will cost them revenue, and maybe even their existence, if nothing changes. But unless the commercial banking sector wakes up and changes how it makes investment decisions, by taking into account the risks associated with environmental change, including stranded assets, we have a problem.”

On stranded assets, she gives the example of how in India in 2018 water shortages meant there was insufficient water to cool thermal power plants, resulting in a loss of 13 terawatts of energy (equivalent to Sri Lanka’s entire annual energy consumption). “If banks start analysing and pricing such risks in the ways suggested by the TCFD, you’ll soon see the rate of change pick up.”

Leapfrogging legacies

In the development banking sector, Kitty does see signs of progress. “The World Bank is slowly moving away from financing fossil fuels; the European Investment Bank is phasing out all fossil fuel financing by 2021. I hope others will quickly follow.”

And finally, she feels FMO has a huge role to play. “In the developed world, we first have to break down our old economy to build a new one. In many parts of Africa, they don’t have to deal with that legacy infrastructure. Which means that by investing wisely, as they are doing, FMO can help African economies leapfrog to a brighter, more sustainable future.

“FMO goes places the public sector won’t. It works with businesses, including SMEs, who provide jobs for young people. If we can get FMO’s portfolio to further expand to poor countries, and become even more resilient and sustainable, I think we’re not just doing the businesses and people we fund in Africa a service; we’re doing ourselves a service. So to FMO I’d say: keep going at it!”