Agree Now, Pay Later

by | Nov 25, 2024 | Risk Report | 0 comments

The rule of the conferences of the parties to the Paris Agreement (COPs) is that nobody leaves until an agreement is reached, which of course ensures an outcome, but not necessarily an outcome anybody wants.

The deal that was reached in Baku, Azerbaijan is that by 2035, developed countries will provide developing countries with at least $300 billion annually in climate change financing. These funds will come from public spending and bilateral and multilateral agreements.

That might sound like a lot of money, and it is, but by all scientific accounts it is not nearly enough to limit the global temperature increase to 1.5C degrees that is deemed the tipping point beyond which climate change will cause irreversible damage to the world as a whole.

So, in addition, the 200 parties agreed to work on releasing another total of $1.3 trillion per year, most of which will come from private sources. Another staggering amount, but please note that these funds are not earmarked for any recipient and will most likely be offered at market terms which might be out of reach for nations already vulnerable to or impacted by climate change.

Another less than desired result was that last year’s COP28 pledge for all parties to transition away from fossil fuel was not—as is tradition—explicitly reaffirmed in this year’s agreement due to resistance from some oil-producing countries.

Fortunately, not all oil producers are like that. The CEO of Exxon Mobil Corp., Darren Woods, attended COP29 in support for reducing global carbon intensity through innovation and investment. Woods said that the solution cannot come from governmental mandates and subsidies alone, but needs the participation of private companies.

This chart shows first and second losses, including  cross-sectoral amplification, across banking, insurance, pension funds, and investment funds sectors.

And in other related climate news; the results of the Fit-for-55 Climate Scenario Analysis by the European Central Bank and Supervisory Authorities were released last week.

The objective of the analysis has been to assess the resilience of the EU financial sector to withstand climate-related shocks and its ability to support the green transition under conditions of stress.

The exercise has been one-off and top-down involving thousands of European financial institutions in banking, insurance, investment and pension funds.

In addition to previous analyses that have mainly focused on the direct impact to the financial sector (first-round losses), this also includes spill-over effects with the sector (second-round losses).

The analysis includes three scenarios, one baseline and two adverse, over an eight-year horizon (2023-2030). The baseline scenario includes all upfront costs to prevent the most extreme economic, societal, and ecological damage as well as the energy-related investments for an orderly transition to a net-zero state.

The two adverse scenarios also include severe, but plausible transition risk shocks, the first one in the form of a sudden flight-to-quality sell-off of brown assets leading to higher financing costs and lower funding for those heavy on brown assets, the second one in the form of a general macroeconomic downturn unrelated to climate risk but potentially making the transition more difficult.

There are two conclusions that stand out from the results. The first one is that the financial sector is more vulnerable to a general macroeconomic shock than to a transition-related shock. That makes sense from the perspective that economic downturns often mean a regression back to wait-and-see rather than continuing change.

The second conclusion is that the banking sector is less impacted than other financial institutions in the analysis which also makes sense given that the banking sector has been tapped to be a frontrunner of the green transition and therefore is further along.

Regitze Ladekarl, FRM, is FRG’s Director of Company Intelligence. She has 25-plus years of experience where finance meets technology.

This article is part of the FRG Risk Report, published weekly on the FRG blog. To read other entries of the Risk Report, visit frgrisk.com/category/risk-report/.