Here is my piece on Blended Finance, published in Artha, the IIM Calcutta finance journal. With investment needs to move to a green economy exceeding $1 trillion a year by 2030, governments and international agencies will find it challenging to fund this. Thus private and public finance will need to join hands. Blended finance blends concessional and market-based finance to fund social and climate needs. I explore the role of blended finance in this article.
Financed Emissions
Banks play a dual role. At one end, they finance decarbonisation; at the other, they finance emissions through loans and investments. Thus, financed emissions are the greenhouse gas (GHG) emissions linked to the investment and lending activities of financial institutions like investment managers, banks and insurers. It’s the carbon footprint of a firm’s investments or loans. There are also facilitated emissions that promote GHG emissions through off-balance-sheet financing activities like underwriting, securitisation and advisory services.
The measurement of financed emissions is a fast-moving area and gets accounted for under Scope 3 category 15 of the Greenhouse Gas Protocol. Only a few of the global banks report financed emissions. Even where they do, measurement methodologies and disclosures vary significantly. 131 banks have committed to reducing their financed emissions and joined the Net Zero Banking Alliance. This is a small fraction of the estimated 25,000 banks worldwide. However, it accounts for 40% of global banking assets.
At heart, the accounting for financed emissions is straightforward. Take the case of a bank with only two bonds of equal amounts in its loan portfolio of power utilities. Bond 1 is from a company that produces 2 kg CO2e per kilowatt hour. Bond 2, on the other hand, produces 1 kg CO2e per kilowatt hour. As a result, the bank has financed 1.5 kg ([2+1]/2) CO2e of emissions. For the bank to meet SBTi targets, the emissions within the loan portfolio should decline to 0.75 kg CO2e.
In practice, assessing and setting targets for financed emissions is not simple. It involves multiple complexities arising from differences between sectors, geographic variation, shifting counterparty plans, changing industry standards, and a nascent and rapidly evolving data environment.
Financed emissions pose a significant risk to financial institutions. They pose a reputational risk from stakeholders who take climate issues seriously. Climate-related regulatory changes may impact the profitability of invested companies and pose a credit risk. Banks that finance carbon-emitting businesses may face financial risk if those businesses are held liable for environmental damage or face penalties for non-compliance with environmental regulations.
Financial institutions need to address and manage the risks posed by financed emissions. Regulatory and governance oversight is critical to ensure banks earn a fair risk-adjusted return while managing climate-related risks.
Spatial finance and sustainability
Satellite technology has become ubiquitous. Satellite imagery has made geospatial data available like never before. Coupled with the increasing availability of real-time geospatial data and advances in artificial intelligence, data-driven decision-making can help fight the climate crisis. The term “spatial finance” was coined by the Smith School of Enterprise and the Environment at the University of Oxford and is based on the understanding that economic outcomes, the natural environment, and geography are interlinked.
Spatial finance integrates geospatial data and analysis into financial theory and practice. Spatial finance helps businesses discover a balance between capitalizing on the earth’s rich bounty and protecting it. Executives are already using this new approach to determine future investments, reduce operational risks, and shape partnerships.
Spatial finance can help identify sustainable investment opportunities by providing financial institutions with more accurate and comprehensive information, enabling them to make better decisions that balance economic outcomes with environmental considerations. Thus, a bank can look at satellite imagery and adjust its investments in an automobile company. Integrating geospatial data into financial decision-making processes allows financial institutions to assess the location of a company’s or a country’s assets and infrastructure using ground data, remote sensing observations, and modelled insights. This offers a potentially transformative means to gain improved quantitative ESG insights. In addition, spatial finance can help increase transparency within the financial system for practitioners and data providers alike, allowing sustainability-related risks to be better managed through the use of geospatial data.
Geospatial data and technologies provide relevant insights across all economic sectors with a direct or indirect link to the physical economy and are a key focus for spatial finance. By illuminating sustainability risks and opportunities as never before, spatial finance can help qualify new categories of risks and extend measurement to places that was previously not possible, thereby creating a smoother transition to sustainable development.
Spatial finance will help companies and NGOs in averting the biodiversity and climate crisis and alleviate the ensuing social issues. It also increases a company’s operations to become more transparent and makes the company more accountable. In addition, spatial finance helps bring a balance to business – balancing environmental and financial objectives. Overall, spatial finance is expected to help financial institutions identify sustainable investment opportunities and enhance sustainable development goals.
The emergence of tree-free paper
Paper is a versatile product and has many uses. It is used for printing, packaging, decorating, writing, cleaning, filter paper, wallpaper, book-end paper, coated worktops, toilet tissue, currency, security paper and several industrial and manufacturing procedures. The global production of paper and paperboard will reach 476 million tons by 2032. Studies estimate that about 42 million trees are cut down daily for paper and other products. It is estimated that in one year, one mature tree absorbs 48 pounds (or 21 kgs) of carbon dioxide. Thus, 332 million metric tons of carbon absorption capacity is being destroyed each year to produce paper. A more sustainable approach to paper production is needed.
Tree-free paper is slowly starting to gain prominence. A wide variety of alternative fibres can replace wood-pulp paper. The sources for tree-free paper include:
* Agricultural residues – for example, sugar cane bagasse, husks, and straw.
* Fibre crops and wild plants – such as bamboo, kenaf, hemp, jute, and flax.
* Textiles and cordage wastes.
There are also non-fibre sources, such as calcium carbonate bound by a high-density, non-toxic polyethylene resin.
The paper industry is highly competitive with low margins and is always searching for cheaper and widely available alternatives. Traditional paper production requires constant planting, cutting and replanting of trees. Although, many paper producers have moved to recyclable paper, it still doesn’t solve the problem of managing forests, as their lifecycle still starts with planting trees. There is also a limit to how many times paper can be recycled. The tree-free paper solves that problem.
Tree-free paper is beneficial for the environment by preventing deforestation. Of course, there is a risk that forest owners may shift the land use to other purposes as they would lose an earnings stream. If the trees no longer need to be planted, there will be a reduction in the use of pesticides and fertilizers. Tree-free paper production creates employment opportunities, generates income, and supports social and cultural values.
Green Deposits 101
The Reserve Bank of India has announced the framework for accepting green deposits of regulated entities (RE).
What is a green deposit?
A green deposit is an interest-bearing deposit received by the regulated entity for a fixed period and the proceeds are earmarked for being allocated towards green finance. These are like your regular fixed deposits issued by banks, and the only difference is that the money collected can be invested only in specified activities.
Why green deposits?
The framework’s purpose is to encourage regulated entities to offer green deposits to customers, protect the interest of the depositors, aid customers in achieving their sustainability agenda, address greenwashing concerns and help augment the flow of credit to green activities/projects.
What are the specified activities?
*Renewable energy
*Energy efficiency
*Clean Transportation
*Climate change adaptation
*Sustainable water and waste management
*Pollution prevention and control
*Green buildings
*Sustainable Management of Living Natural Resources and Land Use
*Terrestrial and Aquatic Biodiversity Conservation
The framework also lists areas where these funds cannot be deployed. These include:
Projects involving new or existing extraction, production and distribution of fossil fuels, including improvements and upgrades; or where the core energy source is fossil-fuel based.
*Nuclear power generation.
*Direct waste incineration.
*Alcohol, weapons, tobacco, gaming, or palm oil industries.
*Renewable energy projects that generate energy from biomass using feedstock originating from protected areas.
*Landfill projects.
*Hydropower plants larger than 25MW
What are the regulated entities?
(a) Scheduled Commercial Banks, including Small Finance Banks (excluding Regional Rural Banks, Local Area Banks and Payments Banks) and
(b) All deposit-taking Non-Banking Financial Companies (NBFCs), including Housing Finance Companies (HFCs).
How do we know the money is invested properly?
he allocation of funds raised through green deposits by REs during a financial year shall be subject to an independent Third-Party Verification/Assurance, which shall be done annually. While assurance is required, the regulated entities cannot wash their hands of their responsibilities.
The RE shall place a review report before its Board of Directors within three months of the end of the financial year.
