RISK-PROOFING CLIMATE FINANCE : Daily Current Affairs

Date: 17/02/2023

Relevance: GS-3: Indian Economy, environmental pollution and degradation, environmental impact assessment.

Key Phrases: Climate Risk and Sustainable Finance, Regulated Entities, Green Debt Securities Framework, Greenwashing, Green Bond Principles (GBP), Yellow bonds, Business Responsibility and Sustainability Report

Why in News?

Reserve Bank of India’s recent consultation paper, ‘Climate Risk and Sustainable Finance’, is an important and timely step towards achieving much-needed awareness regarding climate risk and its systemic implications amongst its regulated entities (REs).

Key Highlights:

The assessment and disclosure of climate risk, while important for the stability of India’s financial system, is also perhaps a window of opportunity for financial institutions to innovate financial solutions and products to support the green transition of industry and society in an impactful way.
It is now widely accepted that financial stress emanating from climate risk doesn't only affects the survival and health of individual lending institutions and a country’s financial systemic stability, but also the functioning of society as a whole.
The ‘Report of the Survey on Climate Risk and Sustainable Finance’, brought out by the RBI, is indicative of the steps being taken by various institutions (low for public sector banks, higher for private sector banks, foreign banks, etc.) to respond to this evolving reality.

Rbi’s Efforts Need To Be Supported By The Following Measures:

End-Use Guidance For Sustainable Finance For REs:
- There is an urgent need to provide more guidance on the end use of sustainable finance by REs, especially regarding which end uses would qualify for sustainable financing as well as an approach to monitoring end-use.
- The Securities and Exchange Board of India’s green debt securities framework’s list of end uses is one step in this direction.
- This could be a starting point for the RBI to develop its own regulation and limit the possibilities of window-dressing or greenwashing.
Definition Of Climate Risk As A Separate Risk Class And Disclosures Of The Same:
- The RBI, in its guidelines, should stipulate a separate formal definition of climate risk for the finance sector wherein the sources of climate risks could be physical, transition, liability, etc.
- Along with the definition stipulation, RBI needs to stipulate basic common disclosures related to this risk class in the organization’s annual reports/periodic filings.
- Encouraging REs to adopt the Task Force on Climate-Related Financial Disclosures (TCFD) guidelines is a welcome move and will improve REs’ acceptability and access to foreign funds/markets where TCFD is almost universally accepted as a disclosure norm.
Capacity Building:
- There is a pressing need for preparing an adequate number of well-trained professionals for RBI’s REs in the rapidly evolving areas of climate risk and sustainable finance.
- A central training body such as the Indian Institute of Banking and Finance (IIBF) may be considered to prepare and provide regular training and technical skills upgradation courses for REs staff who will be part of the departments responsible for climate risk assessment and/or involved in sustainable finance initiatives.

Do you Know?

Markets regulator SEBI has recently strengthened the framework for green bonds by introducing the concept of 'blue' and 'yellow' bonds as new modes of sustainable finance and sub-categories of green debt securities.
Blue bonds relate to water management and the marine sector, while yellow bonds pertain to solar energy.
These measures have been taken in the backdrop of increasing interest in sustainable finance in India as well as around the globe, and with a view to aligning the extant framework for green debt securities with the updated Green Bond Principles (GBP) recognised by IOSCO.

Green Bond Principles:

The Green Bond Principles are voluntary guidelines set out by the International Capital Markets Association (ICMA), an industry body.
They are designed to provide issuers with guidance on the key components involved in the issuance of green bonds.
The Green Bond Principles do not seek to define what green bonds are, or set out comprehensively eligible categories of green bond projects. Rather, they recommend that issuers communicate their use of proceeds categories clearly and transparently so that investors can make their decisions based on their determination of the bond's consistency with their investment strategy.
Most of the green bonds issued by Indian issuers are listed on offshore exchanges as issuers are finding it more attractive to list on bourses falling outside Sebi's framework
The Green Bond Principles consist of four components:
- Use of proceeds
- Process for evaluation and selection
- Management of proceeds
- Reporting

Challenges Of Green Bonds:

One of the main hurdles for further growth has been a consistent and robust approach to identifying what is considered 'green'.
A lack of clarity in this regard leads to 'greenwashing'.
Greenwashing is defined as the practice of channeling proceeds from green bonds towards projects or activities having negligible environmental benefits.

Ensuring RBI Climate Risk Policy Is Based On Empirical Data And Cutting Edge Scientific Research:

Joint Steering Committee: A joint steering committee from the RBI, SEBI, and the Insurance Regulatory and Development Authority (IRDA), under the aegis of the Ministry of Finance (MoF), could start looking at climate risk issues together and come out with a joint policy response for climate risk measurement and mitigation was given the interdependent nature of financial institutions and markets.
Collaboration: The joint steering committee may formally engage with the domestic and international climate scientists community to build on their available data.
Centralised Public Database: A centralized public database about climate vulnerabilities such as inundation in flood-prone areas, heat stress, etc., is key to empowering REs to carry out robust climate risk assessment.
Business Responsibility And Sustainability Report(Brsr): REs can measure the relative climate/ environmental impact of their borrowers by the BRSR for ESG (Environment, Social, and Governance) parameters for the top 1,000 listed Indian companies by market capitalization as well as ESG ratings (assigned by SEBI approved rating providers).
Special Empowered Task Force: The RBI can create a Special Empowered Task Force to study the various sustainable finance instruments issued. This Task Force may bring out half-yearly or annual reports/compendium detailing observations, trends of impact assessment, etc. These documents could provide valuable guidance to financial institutions, both domestic and global.

Conclusion:

The reporting formats are fairly detailed and cover measurable parameters of climate impact such as emissions, generation of pollutants, etc.
This information, thus, may be useful for REs conducting climate risk stress testing and simulations on their loan books at a total portfolio level.

Source: The Hindu BL

Mains Question:

Q. What do you understand by green bonds? What are the challenges faced by green bond finance in India? Suggest measures in order to deal with the financial stress emanating from climate risks. (250 Words).