Report Challenges of Green Finance Private Sector Perspectives from Emerging Markets NOVEMBER 2023 About IFC IFC—a member of the World Bank Group—is the largest global development institution focused on the private sector in emerging markets. We work in more than 100 countries, using our capital, expertise, and influence to create markets and opportunities in developing countries. In fiscal year 2023, IFC committed a record $43.7 billion to private companies and financial institutions in developing countries, leveraging the power of the private sector to end extreme poverty and boost shared prosperity as economies grapple with the impacts of global compounding crises. For more information, visit www.ifc.org. Challenges of Green Finance Private Sector Perspectives from Emerging Markets CHALLENGES OF GREEN FINANCE Page 2 ACKNOWLEDGEMENTS The authors of this report are Dimitri G. Demekas, Adjunct Professor at the School of International and Public Affairs, Columbia University, and Visiting Senior Fellow at the School of Public Policy, LSE; and Jessica Stallings, a sustainable finance consultant in IFC’s Macro and Market Research unit. This report was prepared under the guidance of IFC’s Jean Pierre Lacombe, Director, Global Macro and Market Research. In addition, the report has benefited from comments by Jeffrey Anderson, Sabin Basnyat, William Beloe, Jamie Fergusson, Facundo Martin, Kaikham Onedamdy, and Rhong Zhang (all IFC). Brian Beary and Chris Vellacott edited the report, and Irina Sarchenko was responsible for graphics and design. Page 3  CONTENTS Executive Summary���������������������������������������������������������������������������������������������������������4 Introduction��������������������������������������������������������������������������������������������������������������������6 I. Context: Common Characteristics of Financial Sectors������������������������������������� 10 II. Challenges of the Operating Environment�������������������������������������������������������� 14 III. The Role of Taxonomies and Disclosures�����������������������������������������������������������17 IV. Challenges Related to the Regulatory Environment����������������������������������������21 V. Looking Forward: Risks from the Perspective of the Private Sector���������������� 25 VI: Key Takeaways�������������������������������������������������������������������������������������������������� 27 Annex: Topics for Discussion in Survey Interviews������������������������������������������������������30 CHALLENGES OF GREEN FINANCE Page 4 Executive Summary P rivate financial firms in emerging market that continue business-as-usual. This “first mover and developing economies (EMDEs) have disadvantage” risks holding back the wider adoption of started taking initiatives in the area of sustainable finance practices. green and sustainable finance but face a number Data and capacity gaps hinder the effective application of challenges. The findings of a survey of private of sustainable finance taxonomies and disclosure financial firms from a sample of EMDEs undertaken for requirements. Respondents to the survey indicated this paper suggest that these initiatives are responding that many EMDEs have adopted (or are in the process less to new regulatory requirements—which are still of developing) green or sustainable taxonomies, but at an incipient stage in most EMDEs—and more to these often have limited coverage, are not sufficiently pressures from parent companies of local subsidiaries, granular, or require data and know-how that are foreign investors, other parts of the global financial not always available. As a result, individual financial industry (for example, re-insurers), and development firms have considerable discretion in assessing and finance institutions (DFIs). However, in the absence reporting climate-related exposures and risks. The of common strategies and standards, these initiatives inevitable inconsistencies in disclosures create scope create an uneven operating environment within and for “greenwashing” and aggravate the uneven playing across EMDEs. Firms that would like to adopt more field. ambitious green and sustainable finance goals are hampered by the fear of losing market share to those Page 5 Executive Summary Gaps in the regulatory environment pose a separate industry. Steps toward green and sustainable finance set of challenges. In most EMDEs, central banks and may achieve little if the incentives of investors and financial regulators lag their advanced economy economic actors are not aligned, alternative assets and counterparts in developing and disseminating risk needed technologies are not available, or government assessment models for climate-related risks. In many policies are not consistent. The best course of action cases, this is mainly due to lack of data and expertise. would be for governments to establish transition As a result, individual financial firms are often left to strategies with multi-year emissions targets; carbon their own devices in monitoring and managing these tax and pricing policies consistent with these targets; risks. Against this background, and given the already- appropriate taxonomies with disclosure requirements overloaded regulatory agenda in many EMDEs, private for financial and non-financial companies; and financial firms would need careful preparation and measures to address the data and capacity gaps consultations, staff training, as well as appropriate so as to make these classifications and disclosures transition periods, to be able to implement effectively meaningful. Only with such strategies in place can any new regulatory initiatives in the area of green or the financial industry begin to advance the long-term sustainable finance. reallocation of capital needed for the transition to a low-carbon economy. The perceived absence of a comprehensive, long- term energy transition strategy by governments is perhaps the most significant challenge for the financial CHALLENGES OF GREEN FINANCE Page 6 Introduction C limate change and the challenge of the with equivalent effect); investing in climate adaptation transition to a low-carbon economy have and mitigation; and managing the risks both from the manifold implications for the financial effects of climate change and from the process of the industry. From an economic perspective, climate transition itself (“physical” and “transition” risk) for the change is a negative externality of the production economy.2 This agenda implies evolving risks—as well and consumption of carbon-intensive goods, while as opportunities—for financial firms, and will require a climate mitigation is a public good. The market would major reorientation of capital and financial flows over therefore not reflect the social price of carbon and, the coming decades. Some of these effects are already at the same time, the private return of investments evident, but the process of transition to a low-carbon in decarbonization would be lower than their social economy has only just started. return.1 In addition, climate change creates risks for These are daunting challenges for financial institutions the economy and the financial system. The energy in developing countries. EMDEs are more exposed to transition agenda involves getting carbon prices right physical climate risk than advanced economies, while through carbon taxes (or emissions trading systems insurance coverage of these risks is much lower. At An extensive literature has explored the factors behind the market and government failures that prevent an optimal response to the climate challenge. These include the lack of historical 1  precedent, extreme uncertainty, non-linearities, and tipping points of climate pathways (Stern, N. (2008), “The Economics of Climate Change,” American Economic Review 98(2)); the conceptual difficulties associated with fat-tailed distributions and catastrophic outcomes (Dasgupta, P. (2008), “Discounting Climate Change,” Journal of Risk and Uncertainty 37; Weitzman, M. (2014), “Fat-Tailed Uncertainty in the Economics of Catastrophic Climate Change,” Review of Environmental Economics and Policy 5(2)); the endogeneity of technical change (Acemoglu, D. et al. (2012), “The Environment and Directed Technical Change,” American Economic Review 102(1)); time inconsistency or the ‘tragedy of the horizon’ (Carney, M. (2015), “Breaking the Tragedy of the Horizon – Climate Change and Financial Stability,” Speech by the Governor of the Bank of England at Lloyd’s of London, 29 September 2015); and collective action and free rider problems. Stern, N. et al. (2006), The Economics of Climate Change: The Stern Review, Cambridge University Press; Parry, I. et al. (2014), Getting Energy Prices Right: From Principle to Practice, 2  Washington DC: International Monetary Fund; IMF (2019), Fiscal Monitor: How to Mitigate Climate Change, October 2019, Washington DC: International Monetary Fund. Page 7 Introduction the same time, they tend to rely more on fossil fuels for domestic BOX 1 energy consumption. EMDEs also have, to varying degrees, financial, The Survey of Financial Firms in EMDEs institutional, and capacity gaps The survey of financial firms involved structured interviews with 57 vis-à-vis advanced economies. participants from 29 private financial institutions in a sample of 15 EMDEs, These factors mean that financial as the group is defined by the IMF and commonly used by market participants. These interviews took place in late 2021 and 2022, on the basis firms face higher hurdles in moving of a list of topics for discussion circulated in advance (see Annex). toward green and sustainable finance,3 while climate policy The 15 EMDEs included in the survey were Bangladesh, Brazil, Colombia, frameworks are generally less Côte d’Ivoire, Egypt, Indonesia, Kenya, Mexico, Morocco, the Philippines, Poland, Serbia, South Africa, Türkiye, and Viet Nam. In the World Bank advanced. In addition, EMDE classification, these are all middle-income countries except for Poland, financial sectors share certain which is classified as high-income. These countries were selected on the characteristics that pose special basis of two criteria: regional diversification and the potential for further challenges for financial firms—as IFC engagement. The latter was in turn determined through a combination well as for regulators—in relation of two factors: (i) climate investment opportunities, based on a list of 21 to green and sustainable finance. countries compiled by IFC’s Climate Business Department, where green investment opportunities are estimated to amount to a combined $10 This paper aims to bring the trillion; and (ii) the country selection framework used by the Joint Capital perspectives of private financial Market Program of IFC and the World Bank, which focuses on local firms in EMDEs to bear on these currency capital market development. challenges. This is crucial for two The financial institutions surveyed from this sample of countries included reasons. First, the characteristics of universal, cooperative, and investment banks, insurance companies, and financial sectors in EMDEs are not banking associations. The participating banks, in particular, had combined always given due consideration by assets of $2.7 trillion, representing about 40 percent of total banking assets advanced economy policymakers in these countries. About one third of the financial institutions participating in the survey were foreign-owned subsidiaries or branches of foreign and transnational regulatory financial firms. networks, whose initiatives largely shape the global green Individual interview participants had a wide range of responsibilities within and sustainable finance universe. their companies. Almost one third held positions in risk management, such as credit risk officers and heads of underwriting and portfolio Second, even when advanced analysis. Another third had roles related to strategic management, such as economy and EMDE regulators corporate strategy, product development, and investor relations. The rest included sustainable finance or Environmental, Social, and Governance leads, regulatory affairs officers, and a number of CEOs. Figure 1 shows the geographical distribution of interview participants, as well as their roles Although the terms are often used interchangeably, 3  “green finance” strictly speaking refers to financing within their companies. projects or investments with environmental benefits, and “sustainable finance” to activities supporting sustainable development goals more broadly.. CHALLENGES OF GREEN FINANCE Page 8 talk with each other and share experiences, for example through FIGURE 1 the Network for Greening the Financial System and the Participation in the Survey of Financial Firms Sustainable Banking and Finance Network, the concerns of the private sector do not always come to the forefront. These perspectives are based on a survey of private financial firms 31% Europe and Central Asia 29% Risk management in a sample of EMDEs undertaken for this purpose. The sample selection process, methodology, and participants in the survey are presented in Box 1. Although the total number of financial firms that participated is small relative 28% Asia and the Pacific 29% Corporate strategy to the universe of financial firms in EMDEs, the findings suggest a number of emerging patterns and shared concerns that are worth highlighting. 13% Treasury The paper is organized as follows: 24% Africa Section 2 summarizes certain 11% Sustainable finance features of EMDE financial systems that determine the context in which their green and sustainable 8% CEO finance efforts are unfolding. 17% Latin America Section 3 discusses challenges 6% Regulatory a airs for green and sustainable 4% Banking association finance related to the operating environment for financial firms in EMDEs, reflecting market Source: Authors’ calculations. forces and the broader political and economic context. Section 4 Page 9 Introduction reviews the role of taxonomies and disclosures and the experiences of EMDEs in this regard. Section 5 discusses the challenges arising from the regulatory environment EMDE financial firms are facing in relation to climate risk and green finance. Section 6 discusses the risks related to green and sustainable finance as seen by private financial firms in EMDEs. Each of these sections is informed by the findings of the survey and, where relevant, the economic literature, and the lessons learned from the experience of advanced economies. The final section summarizes the key takeaways from the survey about the possible role of IFC going forward. CHALLENGES OF GREEN FINANCE Page 10 I. Context: Common Characteristics of Financial Sectors F inancial sectors in EMDEs share certain makes the task of estimating and mitigating climate- characteristics that are different than related financial risks more urgent but also more those in advanced economies. Some of these complex, given the data and capacity gaps. differences can have a major impact on the success of efforts to introduce climate-related considerations in Limited insurance coverage for climate- business decisions and, more broadly, on the design related losses. of green and sustainable finance policy frameworks In addition to the greater vulnerability to climate- in these countries. In addition to gaps in human and related risks, the penetration rate of non-life insurance financial resources, expertise, and data infrastructure remains low in many EMDEs, leaving significant gaps vis-à-vis advanced economies, there are five specific in protection for losses related to natural catastrophes characteristics of EMDE economies and financial (Figure 3). systems that are directly relevant to the issue at hand: Bank-dominated financial sectors, Vulnerability to climate-related risks. shallow financial markets. EMDEs are relatively more vulnerable to the impacts of In most EMDEs, banks tend to dominate financial climate change than developed countries.4 For EMDEs systems, with both the public and private sectors as a group, the frequency of climate-related disasters relying mainly on banks for credit. Capital market has increased threefold since 1980 (Figure 2). This depth and liquidity are limited, in part reflecting See Intergovernmental Panel on Climate Change (2022) Climate Change 2022: Impacts, Adaptation and Vulnerability, Summary for Policymakers. 4  Page 11 I. Context: Common Characteristics of Financial Sectors FIGURE 2 Frequency of Climate-Related Natural Disasters 900 800 Number of disasters 700 600 500 400 Emerging markets 300 200 100 Developed markets 0 1981 1982 1983 1991 1987 1992 1988 1985 1993 1986 1989 1997 1998 1984 2006 1995 1996 1999 1980 1994 2001 2002 1990 2003 2005 2004 2000 Source: Emergency Events Database (EM-DAT), CRED/UCLouvain. the lack of adequate market infrastructure (Figure 4).5 Although FIGURE 3 this limits the available financing channels for the private sector, Natural Catastrophe Protection Gaps by Region Uninsured losses as a share of total losses related to including for energy transition natural catastrophes, 2018 projects, it facilitates the task of central banks and financial Africa regulators: in contrast to their Latin America and the Caribbean counterparts in advanced Europe economies and some EMDEs with Asia more diversified financial sectors, Oceania they can worry less—at least in the short term—about the role of North America 0 20 40 60 80 100 Percent of uninsured losses Rojas-Suarez, L. (2014) Towards Strong and Stable Capital 5  Markets in Emerging Market Economies, BIS Paper No. Source: SwissRe. 75c, Basel: Bank for International Settlements. CHALLENGES OF GREEN FINANCE Page 12 less regulated non-bank financial FIGURE 4 intermediaries. Financial Sector Structure in EMDEs, 2021 Significant presence of foreign banks. Share of banks in domestic credit to private sector The large presence of foreign bank branches and subsidiaries in South Asia many EMDEs (Figure 5) is often a East Asia and the Pacific positive factor for competition in Europe and Central Asia the provision of financial services and for the process of financial Middle East and North Africa deepening. At the same time, it Latin America & the Caribbean creates an uneven playing field and a challenge for regulators. Sub-Saharan Africa Foreign banks often have to follow High income policies and priorities determined by their parent company without 0 50 100 regard to the circumstances in the Percent host jurisdiction or the priorities of Stock market capitalization the host regulator. This creates a two-speed banking system, with Europe and Central Asia important effects on the adoption of environmental, social and Latin America & the Caribbean governance (ESG) considerations, including climate, in bank business East Asia and the Pacific practices. Middle East and North Africa High income 0 100 200 Percent of GDP Note: Regions are those defined by the World Bank, excluding high-income economies in those regions. Aggregate data are not available for stock market capitalization in Sub-Saharan Africa. Source: Authors’ calculations based on World Bank data. Page 13 I. Context: Common Characteristics of Financial Sectors Greater dependence on fossil fuels. FIGURE 5 EMDEs rely more heavily on fossil Foreign Bank Penetration in EMDEs, 2020 fuels than developed markets (Figure 6). Coal, oil, and natural Africa 22% gas account for almost 90 percent of both energy production and Europe and Central Asia 19% consumption in EMDEs. This Asia and the Pacific 14% reliance complicates the political and economic incentives for these Latin America 9% countries to transition to low- carbon energy sources. Note: Based on the sample of countries in the survey. Source: Fitch. FIGURE 6 Composition of Energy Production and Consumption, 2019 Developed markets Emerging markets 12.2% Consumption 36.7% Coal Coal 15.9% Production 33.5% 39.4% 28.5% Petroleum and other liquids Petroleum and other liquids 27.2% 33.3% 27.6% 22.3% Natural gas Natural gas 30.1% 21.9% 8.5% 2.2% Nuclear Nuclear 10.6% 2% 12.9% 10% Renewables and other Renewables and other 16.3% 9% Source: World Bank, US Energy Information Administration. CHALLENGES OF GREEN FINANCE Page 14 II. Challenges of the Operating Environment T he context in which financial firms operate green finance. The role of regulation is discussed has a major influence on their strategic separately. priorities and business practices, including The operating environment in EMDEs is fragmenting, the ways they approach green and sustainable with some financial firms coming under much greater finance. Like all companies, financial firms must adapt pressure than others to incorporate climate-related to their environment in order to maximize value. In considerations in their business. This pressure does addition to the “hard constraints” posed by legislation not, as a rule, appear to come from the regulators, and regulation, this places “soft constraints” on whose efforts in this area are still at a preparatory financial firms, including market conditions, capacity stage in many EMDEs,6 but from sources mainly within constraints, competitors’ actions, and pressures the industry. The result is an increasingly uneven coming from shareholders, funding providers, and playing field, which holds back many financial firms other stakeholders, as well as from the broader social from adopting green and, more broadly, sustainable and political trends. These “soft” factors are crucial finance practices. determinants of the way financial firms approach green and sustainable finance, the speed with which Pressures on sustainability are coming they are able to move, and the limitations they face. This section reviews the evidence provided by from diverse sources. participants in the survey regarding such “soft” factors For foreign-owned subsidiaries or branches of in EMDEs as they relate to climate-related risk and foreign financial firms headquartered in advanced For a survey of regulatory initiatives in EMDEs in this area, see SBFN (2021), Accelerating Sustainable Finance Together, Global Progress Report, October 2021, Sustainable Banking and 6  Finance Network. Page 15 II. Challenges of the Operating Environment economies, the parent company is the biggest the hope that DFIs could improve coordination among source of pressure to adapt business practices to themselves. meet climate and broader sustainability objectives. For insurance companies, in particular, the role of As the representatives of a Serbian subsidiary of re-insurance is critical. As one insurer in Côte d’Ivoire an EU bank put it, there was “huge pressure from mentioned, “their influence is greater than that of our the parent company to build local capacity [for regulator.” The first steps in their adapting business assessing the environmental impact of potential practices to reflect climate risks were likely to be taken clients], create sustainability-related KPIs, and in response to pressure from re-insurers. incorporate sustainability considerations in the credit approval process.” Parent companies are training In some cases, developments in the local market, local staff, helping build local capacity for climate- notably actions by a market leader, are creating related modeling, and in many cases simply forcing pressures on other firms to adapt. In Brazil, for local companies to adopt and use ESG-related example, the adoption of “Agenda 2030” by giant classification criteria developed by the parent (even state-owned development bank BNDES was a major though these are not always practical in the local contributing factor in pushing other financial firms to context). This experience was reported time and again introduce sustainability aspects to their business. by respondents in subsidiaries of foreign financial In contrast, little pressure was reported from firms across all regions. In some cases, broader shareholders (other than parent companies), environmental policies or targets adopted by the although this appeared to vary with the level of parent group are expected to be followed by branches market development. In EMDEs in Africa, in particular, and subsidiaries everywhere. Representatives of one respondents indicated that climate did not appear multinational bank in Asia, for example, reported that to be important for domestic shareholders. In the group as a whole had decided to stop financing more financially advanced EMDEs, on the other coal-fired energy generation and logging throughout hand, notably in Latin America, current or potential its area of operations regardless of individual country shareholders were described as more sensitive to circumstances. On the other hand, foreign subsidiaries climate-related issues. The representatives of one or branches of banks headquartered in other EMDEs, Brazilian insurer, for example, reported that the like China, were not under similar pressure from their decision to take the company public had forced parent. management to develop an ESG agenda in order to Pressure to adapt business practices also comes from attract investors. Development Finance Institutions (DFIs), including IFC, Survey participants also reported not feeling strong in their capacity as investors or sources of financing. pressure from civil society or from the broader A number of survey participants, however, noted that social and political environment in their countries to this effect was blunted because each DFI seemed to accelerate their move toward green finance. follow its own standards and policies, and expressed CHALLENGES OF GREEN FINANCE Page 16 Activists and NGOs, although present everywhere, do representatives of local financial firms, who were not appear to have a noticeable influence on EMDE concerned that incorporating strong sustainability financial firms’ climate and sustainability agendas. standards might begin to erode their market share. This assessment was uniform across all respondents. As the representatives of an Egyptian insurer put it, Awareness of climate issues among other economic “competitors are waiting to take the business we actors and society more broadly varied widely reject.” Similar concerns were expressed by a West across the sample of countries. Some respondents, African banking group about local competitors who particularly in Africa, mentioned that the issue was were “happy to take coal mining and palm oil clients” not high on the political agenda and was even seen by that the group was considering dropping. some as an attempt to impose “advanced economy This uneven playing field creates a “first mover standards on developing countries.” A majority of disadvantage” that can hold back the adoption of participants across all regions expressed the view that green or sustainable financing practices. Many firms it was important to adapt this global agenda to local reported feeling caught between two opposing forces: needs and capabilities, and that policy changes needed their desire to move faster toward sustainable finance to be “digestible” by the financial industry and by and their concern about losing market share. Survey society at large. participants felt that this conundrum could only be resolved by regulators taking steps to level the playing An uneven playing field is putting some field. firms at a competitive disadvantage. These unequal pressures open a rift between two types of approaches to climate-related issues within many EMDEs. On one side are financial firms that feel pressure from parent companies, investors, re- insurers, or other stakeholders to green their activities; on the other, are smaller, mainly local firms that are under little or no such pressure. This creates an uneven playing field, providing a competitive advantage to the latter group of firms. This was stressed by representatives of foreign subsidiaries, whose parent companies had imposed strict sustainability standards that had started affecting negatively the bottom line. Their competitors, including local firms and foreign subsidiaries whose parents had less demanding environmental standards, continued to do business with clients that the first group could not access. The same point was also underscored by some Page 17 III. The Role of Taxonomies and Disclosures III. The Role of Taxonomies and Disclosures T axonomies and the associated disclosure In practice, however, the magnitude and speed of requirements are key elements of any this capital shift depend on a number of factors. green or transition-focused policy These include how quickly heterogeneous investor framework and can, at least in theory, help direct preferences translate into aggregate demand for capital toward climate goals.7 The disclosure of green assets; whether issuers are able to respond to certain characteristics—for instance, greenhouse gas this demand; and—since most real-world investment emissions—provides investors with better information transactions involve financial intermediaries—how on which to make informed decisions in line with their effectively these large, complex organizations move preferences. There is also an indirect benefit, since to incorporate such considerations into their business transparency of the climate impact of a borrower’s practices. activities would help financial firms improve the Two additional complications limit the effectiveness of assessment of their climate exposures, thereby taxonomies and disclosures:8 enabling them to limit future climate-related risks to financial stability. These effects would, in theory, • They can be applied to two different types induce a shift in capital toward green activities. of information: unevaluated quantitative or qualitative information (“raw data”) and summary For the standard economic analysis on dealing with activities that entail environmental externalities, see Baumol, W. (1972), “On Taxation and the Control of Externalities,” American 7  Economic Review, 62(3): 307-322; Deewes, D. N. (1983), “Instrument Choice in Environmental Policy,” Economic Inquiry, 21(1): 53-71; and Deewes, D. N., F. Mathewson, and M. Trebilcock (1983), “The Rationale for Government Regulations of Quality and Policy Alternatives in Quality Regulation,” in: Deewes, D. N. (ed.), Markets for Insurance: A Selective Survey of Economic Issues, Butterworth. Steuer, S. and T. H. Tröger (2022), “The Role of Disclosure in Green Finance,” Journal of Financial Regulation, 8: 1-50. 8  CHALLENGES OF GREEN FINANCE Page 18 assessments (“labels”). In ideal, frictionless of the multitude of different underlying economic markets, where rational agents can process activities. information costlessly, disclosure of raw data would be sufficient; in real-world markets, limited Taxonomies and disclosures have spread resources and transaction costs mean that labels rapidly in advanced economies, but are generally more useful. However, to be effective the experience has highlighted their as tools to reallocate capital to more sustainable limitations. activities, labels must be accurate, consistent, and Voluntary green taxonomies and disclosure standards credible, which in turn depends on the availability proliferated during the last decade in response to of high-quality data and on rigorous, transparent, increasing investor interest in ESG issues. Most and auditable assessment processes. were developed by industry groups, environmental • They can be applied to three different levels advocates, ESG advisers, or international organizations. of economic activity: an individual product or The International Organization of Securities activity (e.g., electric car production); a company Commissions has identified more than 45 such seeking financing (issuer); or an asset portfolio initiatives (Table 1). that combines instruments from different issuers. Most of these initiatives have major shortcomings Applying taxonomies to an individual product in the areas of transparency, governance, and or activity is the most coherent and transparent auditability. Many products are labeled by their issuers approach. Unfortunately, doing so is fraught with (or by ESG advisers) as “green” or “sustainable” without data and measurement problems (coverage of a clear link to the ways in which the product may supply chains, impact over the product life cycle, be contributing to climate or sustainability goals, estimate of recyclability, etc.). Applying taxonomies and there is no external evaluation of compliance. to companies or issuers (as, for example, with As a result, different providers often come up with green bond taxonomies) has the problem that different ratings for the same companies.10 The lack money is fungible and, in line with standard of consistency and rigor in defining and applying corporate finance theory, debt instruments are these criteria, as well as extensive evidence of issuer-level financing devices and do not fund “greenwashing,”11 risk undermining the credibility of a specific activity.9 And applying taxonomies these classifications.12 to an entire portfolio (e.g., an investment fund) further obscures the real environmental impact Asset-backed securitizations may be an exception to this rule, but they are not widely used in many EMDEs. 9  10 Murray, S., “Navigating the thicket of ESG metrics,” Financial Times, October 24, 2021. Amenc, N., F. Goltz, and V. Liu (2021), Doing Good or Feeling Good? Detecting Greenwashing in Climate Investing, Paris: EDHEC Business School. 11  NGFS (2021), Sustainable Finance Market Dynamics, NGFS Technical Document, Network for Greening the Financial System; OECD (2020), ESG Investing: Practices, Progress and 12  Challenges, Paris: Organization for Economic Cooperation and Development. Page 19 III. The Role of Taxonomies and Disclosures TABLE 1 ESG-Related Initiatives and Guidelines Categories Quantity Disclosure and reporting principles and frameworks used by companies and issuers 12 Principles and frameworks applicable to asset managers 4 Green bond principles and taxonomies 7 Coalitions and alliances related to ESG 17 Other initiatives 8 Source: IOSCO, Sustainable Finance and the Role of Securities Regulators and IOSCO, Final Report, April 2020, International Organization of Securities Commissions. Since the various standards are not consistent, it is Based on this experience, researchers at the Bank not clear that they can direct capital effectively to for International Settlements have put forward the sustainable investments. To address this problem, the following five principles for the design of effective International Financial Reporting Standards (IFRS) sustainable finance taxonomies:15 Foundation announced at COP26 in 2021 the formation 1. Alignment not only with the high-level policy of an International Sustainability Standards Board objective but also with measurable interim targets, (ISSB).13 The ISSB is meant to build on the work of since the high-level objective (e.g., achieving net existing reporting initiatives14 to become the global zero) may be beyond the time horizon of investors. standard setter for sustainability disclosures. In June 2023, the ISSB issued IFRS S1, General Requirements 2. Focus on one single objective (“one taxonomy, for Disclosure of Sustainability-related Financial one objective”), otherwise investors would be Information. uncertain about exactly what information the “label” conveys. 3. Focus on outcome-based, simple, and measurable KPIs, rather than on abstract principles. This would “IFRS Foundation announces International Sustainability Standards Board, consolidation with CDSB and VRF, and publication of prototype disclosure requirements,” Press Release, 13  November 3, 2021. These include the work of the Climate Disclosure Standards Board (CDSB), the recommendations of the Task Force on Financial Disclosures (TCFD), the Value Reporting Foundation’s 14  Integrated Reporting Framework, the Sustainability Accounting Standards Board (SASB) standards, and the World Economic Forum’s Stakeholder Capitalism Metrics. Ehlers, T., D. Gao, and F. Packer (2021), “A taxonomy of sustainable finance taxonomies,” BIS Papers No. 118, October 2021, Basel: Bank for International Settlements. 15  CHALLENGES OF GREEN FINANCE Page 20 allow low-cost, independent verification of the collect the same data and indicators on the climate process and the certification. impact of their assets, each bank applies a different methodology in assessing their compliance. This 4. Incorporation of both activity-level and company- problem was exacerbated for multinational financial level information, to avoid the potential for firms that are facing different approaches and “greenwashing” in case of classification of issuer- requirements across the jurisdictions where they based instruments. operate, as was reported by representatives of a 5. Sufficient granularity, covering both high and low Morocco-based insurer active in a number of in Sub- sustainability performance, to allow differentiated Saharan African countries and a multinational bank (“shaded”), rather than just binary (“green-brown”) active in Asia. classifications. The key limitation for effective application of The survey findings suggest that taxonomies are taxonomies in EMDEs, according to participants, is increasingly used in EMDEs but fall well short of data availability. The data needs vary from country the principles required for effectiveness. In many of to country and are often sector specific. The the countries in the sample, green taxonomies or representatives of a Serbian insurer, for example, other sustainability-related classification systems mentioned the need to collect detailed data on for economic activities or real assets (e.g., buildings) rainfall by region to enable insurance companies to have been introduced or are under consideration. assess drought risk, while a Mexican bank mentioned These taxonomies are typically the responsibility of the need for data on coastal erosion to assess the legislatures, not financial regulators, and are primarily risk for loans to tourism establishments. Such data focused on real sectors, especially energy generation, were beyond what could be collected by individual construction, agriculture, and transportation. In some financial firms: coordinated efforts were needed cases, countries have simply imported a ready-made instead. Several participants also mentioned that taxonomy from another jurisdiction, while in others, the lack of know-how and tools for using these data countries have devised their own, reflecting domestic to assess climate-related risk were major obstacles, priorities. Participants noted that these taxonomies underscoring the need for more training and capacity are typically very high-level, binary (“green-brown” building in the industry. Representatives of subsidiaries or “clean-dirty”), and vary widely in their coverage or branches of foreign financial firms felt that this was (in some cases, covering only “priority sectors”). less of a constraint. Finally, some participants, such They do not always specify the data required to set as a Philippine bank, cautioned against a “one-size- KPIs and assess compliance or, in cases where they fits-all” approach, noting that importing standards do, the required data are not always available. As a developed in advanced economies might not fit the result, individual financial institutions typically have financial landscape in EMDEs. substantial discretion when it comes to assessing their compliance with the taxonomy. One banking association noted that while banks in its jurisdiction Page 21 IV. Challenges Related to the Regulatory Environment IV. Challenges Related to the Regulatory Environment T he experience of advanced economies with analytical and conceptual challenges. The interactions climate-related financial regulation holds between climate and economic systems have been important lessons for EMDEs. Following studied for decades but it was not until the middle the Paris Agreement, the G20 Finance Ministers of the last decade that central banks and regulators and Central Bank Governors tasked the Financial began attempting more systematic stress-testing Stability Board in 2015 to “convene public- and exercises to capture climate-related risks for banks private-sector participants to review how the and other segments of the financial system. Despite financial sector can take account of climate- the increasing sophistication of these exercises, related issues.”16 Since then, a number of regulators, however, their scope for guiding policy remains mainly in advanced economies, have been working on limited. First, the scenarios need to incorporate drastic two parallel tracks: trying to measure the magnitude simplifying assumptions in order to overcome the of climate-related risks for the financial system, and modeling challenges stemming from the complexity considering the appropriate regulatory response.17 and radical uncertainty about the possible climate pathways, as well as from the decades-long time Significant progress has been made in developing tools horizons. This increases model risk: minor technical for assessing climate-related financial risks but, at the decisions about functional forms and parameter values same time, the experience has revealed a number of can dominate the results. Second, the restrictive G20 Finance Ministers and Central Bank Governors’ Communiqué, Washington DC, 17 April 2015. 16  There is an extensive literature on the theoretical and practical aspects of climate-related financial regulation drawing on the experience of advanced economies, which lies beyond the 17  scope of this paper. A comprehensive survey can be found in Demekas, D.G. and P. Grippa (2022), “Walking a Tightrope: Financial Regulation, Climate Change, and the Transition to a Low-Carbon Economy,” Journal of Financial Regulation, 8: 203-229. CHALLENGES OF GREEN FINANCE Page 22 assumptions routinely made in stress tests (notably, type of incentive—has had no material influence on constant balance sheets) tend to overestimate losses lending to small- and medium-sized enterprises.21 In since, in reality, over such long time horizons, banks addition, recent estimates show that even a massive would be able to adjust their balance sheets and even GSF (effectively halving the capital requirement for business models toward less climate-risky assets. green projects) would have a very small impact on Third, in the exercises that have been completed so overall credit growth and on financing for green far, the estimates of the potential losses and capital projects.22 Another proposal—using macroprudential needs related to climate risk fall within a very wide instruments to address climate-related risk—is range, from negligible to severe.18 Such a wide range of hampered by the fact that standard macroprudential results does not provide a firm basis for policy action instruments (such as systemic buffers or capital add- today. ons) may not be effective when deployed to address the systemic implications of climate risk while, at the In addition, the existing prudential toolkit may not be same time, creating difficult trade-offs.23 Last but well suited for addressing climate-related risks. One not least, since it took regulators decades to agree proposal that initially gained some popularity was to on a common standard for risk-based prudential encourage the allocation of bank lending to green requirements, ad hoc departures from this standard sectors by adjusting risk weights through a “Green risk increasing fragmentation and hampering Supporting Factor” (GSF) and a “Brown Penalizing supervisory cooperation. Factor” (BPF).19 Further consideration, however, led to a number of objections. Since the empirical evidence Against this background and given the current that green assets are less risky is at best weak,20 limitations of available data and modeling the GSF might result in an unwarranted weakening uncertainties, advanced economy regulators are of total capital. Moreover, adjusting risk weights is proceeding cautiously. None have yet taken action unlikely to achieve the sizeable shift in credit required to address future losses estimated in climate- for decarbonization. The evidence shows that the related stress tests, although they have underscored European Union’s “SME supporting factor”—a similar that these exercises can still be useful as they raise One such exercise concluded that “between 3.8 percent to 29.9 percent of the Common Equity Tier 1 capital of the banking system is wiped out in first-round losses” (Reinders, H., 18  Schoenmaker, D., and Van Dijk, M. (2020), A Finance Approach to Climate Stress Testing, London: Centre for Economic Policy Research. An ECB exercise concluded that in the most severe scenario, the increase in probabilities of default for banks’ portfolios would range from 5 to 30 percent over a 30-year horizon (Alogoskoufis, S., et al. (2021), ECB Economy-wide Stress Test, Occasional Paper No. 281, September 2021, European Central Bank. EU policymakers seem to have considered this step. See Dombrovskis, V. (2017) ‘Greening finance for sustainable business,’ Speech by the Vice President of the European Commission, 12 19  December 2017, Brussels: European Commission. See Giglio, S., Kelly, B.T., and Stroebel, J. (2020), Climate Finance, NBER Working Paper 28226, National Bureau of Economic Research. Overall, there is limited evidence that broader 20  market prices incorporate risk premia commensurate with the scale and nature of climate-related risks across different sectors (see IMF (2020), “Physical Risk and Equity Prices,” Global Financial Stability Report April 2020, Washington DC: International Monetary Fund). In addition, risk reductions that may appear linked to the “green” nature of an exposure could be the result of other factors, such as government subsidies or tax advantages. 21 EBA (2016), EBA Report on SMEs and SME Supporting Factor, Report 2016/04, European Banking Authority. Chamberlin, B. and Evain, J. (2021), Indexing Capital Requirements on Climate: What Impacts Can Be Expected, Paris: Institute for Climate Economics (I4CE). 22  Coelho, R. and Restoy, F. (2023), “Macroprudential policies for addressing climate-related financial risks: challenges and tradeoffs,” FSI Brief No. 18, Basel: Bank for International 23  Settlements. Page 23 IV. Challenges Related to the Regulatory Environment awareness of climate risks and provide incentives or “listening” mode in such events. for improving risk management in financial firms. In some cases, financial regulators have gone a step Instead of introducing specific climate-related further and recommended or required financial firms prudential requirements, some regulators have to disclose the environmental footprint/impact of issued as a first step supervisory guidance (guidelines their exposures. However, the scope and coverage of or interpretations of existing rules, which amount such disclosures vary widely across countries. In some to recommendations that fall short of a regulatory cases, such as Viet Nam, disclosures are expected to requirement) on how financial firms should monitor cover not only the environmental but also the social and manage climate-related risks.24 On the whole, impact of loans. In several cases, the regulator expects advanced economy regulators seem to have concluded banks to assess and report the climate/environmental that they should focus on the consequences of climate footprint of their exposures but does not provide change for financial firms (in terms of increased detailed guidance or classification criteria on how to physical and transition risk), while steering clear of do so. Even in the cases where guidance is provided, climate policy-making that is supposed to address the most respondents felt that it is too high-level, causes of climate change.25 general, or otherwise inadequate. Without detailed The survey suggests that the regulatory environment guidance from the regulator, many respondents felt in EMDEs is evolving in the same direction as in that such disclosures may be misleading. A number of advanced economies but is facing greater challenges, representatives of foreign subsidiaries, whose parent particularly as regards the development of tools for companies had introduced detailed methodologies assessing and managing climate-related risks. for calculating the environmental impact of their exposures, felt that the lack of a uniform and rigorous In almost all cases, respondents indicated that their methodology in their jurisdiction indirectly favors regulator is aware of climate-related challenges domestic competitors applying less strict standards. and has engaged in some sort of outreach with the industry. This often takes the form of surveys of how There is so far little progress toward developing a individual financial firms were assessing and managing systematic quantitative scenario analysis of climate- climate-related risks and roundtable discussions or related risk in the jurisdictions covered by the survey. other events designed to raise awareness of the issues. Lack of data and lack of expertise with quantitative In some cases, these initiatives are undertaken jointly tools, such as the climate stress tests used in some with (or exclusively by) industry associations. More advanced economies, are the key reasons behind this, often than not, the regulator seems to be in “learning” according to respondents. The ECB and the Bank of England have set out supervisory expectations for banks to analyze climate-related risks, incorporate them into their risk appetite framework, report data 24  that reflect their exposures to climate-related risks, and take them into account in the credit-granting process and the operational risk management framework (PRA (2019), Enhancing Banks’ and Insurers’ Approaches to Managing the Financial Risks from Climate Change, PRA Supervisory Statement SS3/19, London: Bank of England; ECB (2020), Guide on Climate- Related and Environmental Risks: Supervisory Expectations Relating to Risk Management and Disclosure, Frankfurt: European Central Bank). PRA (2021), Climate-related Financial Risk Management and the Role of Capital Requirements, PRA Climate Adaptation Report, London: Bank of England Prudential Regulation 25  Authority. See also the recent statement by Fed Chair Powell (“Powell Says Fed Will Not Become a ‘Climate Policy Maker’,” WSJ, January 10, 2023. CHALLENGES OF GREEN FINANCE Page 24 When asked about the possible scope for additional A point of unanimous agreement was the need for the climate-related regulatory action in their jurisdictions, regulator to assist financial firms with data, knowhow, survey respondents expressed diverse views. Opinions and tools to assess climate-related risks and to ensure generally fell into two groups—albeit with exceptions. a level playing field. All respondents emphasized that Respondents from relatively more advanced and regulators should play a more active role in enforcing sophisticated financial sectors, such as in South Africa, “comparability and completeness” of climate-related Latin America, and some Eastern European countries, disclosures to eliminate the “first mover disadvantage” saw little need for additional regulatory action (other for firms considering applying stricter standards. than implementing more uniform taxonomies), This would involve, at a minimum, a uniform ESG arguing that shareholder, investor, and market taxonomy, detailed guidance on classification and pressures would be sufficient to steer financial firms disclosures, clear regulatory expectations, and toward sustainable finance. Respondents from parts close follow up. Moreover, in countries where the of Africa and Asia, on the other hand, saw scope for government had a national climate transition strategy, more active intervention to guide the financial sector the regulator should ensure that all financial firms in the transition to a low-carbon economy. Among were subject to the same compliance requirements. those who favored additional action, many were against using the capital framework—for example, imposing capital surcharges on “brown” exposures or using GSF/BPF to adjust risk weights—noting, in line with the evidence in advanced economies, that there is no indication that green loans or assets are less risky. Others felt that reducing capital charges (through a GSF) for green projects would be appropriate but were against increasing charges for “brown” projects. Echoing the lessons learned in advanced economies, a Turkish bank representative mentioned that financing costs are a small part of the total cost of polluting activities, and a carbon tax would be much more effective than any tweaking of capital requirements. Others favored using public subsidies or guarantees, rather than regulatory tools, to encourage green and sustainable finance. Only one respondent favored using administrative tools to direct credit, such as setting quantitative credit targets or floors for certain sectors. Page 25 V. Looking Forward: Risks from the Perspective of the Private Sector V. Looking Forward: Risks from the Perspective of the Private Sector P articipants were aware that the move on which to base compliance, as well as the lack of toward green and sustainable finance would staff in financial firms with the right skills to monitor create opportunities, as well as risks for the and manage climate-related risks. In many cases, industry. With respect to the latter, however, their regulatory approaches and tools are developed with preoccupations were somewhat different than those data from advanced economies rather than EMDEs. in advanced economies, with most participants in As the representative on an Indonesian bank put it, the survey taking the view that the most significant climate-related regulatory changes should be part of a risks in EMDEs relate to the policy and regulatory “long-term road map for sustainable finance, not one- environment. shot measures.” The main concern was the risk of a sudden or A related concern was overloading the regulatory rushed move by their national regulator, perhaps agenda. A South African insurer mentioned that under pressure from international standard setters. with IFRS and Solvency II [a European Union Respondents almost unanimously underscored the Directive], the agenda was already “overcrowded.” need for extensive consultation with the industry and The representatives of an African bank noted that sufficiently long transition periods for any regulatory digital finance, micro finance, and financial inclusion measures relating to climate or sustainability initiatives were already at the top of the priority list objectives. This was particularly relevant given the for many African countries. In Mexico, the recent dearth of relevant and sufficiently granular data introduction of the Total Loss Absorption Capacity— CHALLENGES OF GREEN FINANCE Page 26 or TLAC—regulation may have been too rushed,26 “greenwashing” if all investors and financial firms—in according to the representatives of a local bank, and anticipation of or prompted by regulators—sought at both the supervisor and the banks are now under the same time to increase their green exposures. pressure to adjust to the new requirements. In these Only a handful of respondents expressed concern conditions, adding another regulatory priority would about the activities of non-bank financial not only increase compliance costs for financial firms intermediaries, like asset managers and private but would also stretch the resources of the supervisor. equity, which are generally less tightly regulated. The perceived lack of policy coordination with These concerns were expressed by firms in the more the government also troubled respondents. developed financial sectors in the sample, such as Notwithstanding the different views about the Brazil and Poland. In most other countries covered by role financial regulation could play in the green the survey, respondents did not seem to consider this transition, all respondents stressed that regulatory an issue, probably because banks are still the dominant initiatives should be closely coordinated with source of finance. government policies. This would not only guarantee their effectiveness but would also lower the risk of unnecessary volatility during the transition. Respondents also underscored that limiting finance flows to greenhouse gas-intensive sectors—notably energy generation in economies still relying on coal— before alternative sustainable energy sources are in place risks jeopardizing support for the transition, and called for comprehensive and credible long-term transition plans that take this into account. Participants also noted risks unrelated to the policy and regulatory environment. One concern similar to those in advanced economies was that, given the scarcity of investable projects, a rushed move toward green and sustainable finance could create a severe demand-supply imbalance and destabilize the market. The representatives of a Kenyan bank, as well as other respondents, noted that the lack of green assets in EMDEs could fuel a bubble and stimulate further The Total Loss Absorption Capacity (TLAC) standard is part of the post-GFC regulatory reforms. It requires systemically important banks (SIBs)—as determined by the regulator in each 26  jurisdiction and, for global SIBs, by the FSB—to hold, in addition to minimum capital requirements, a certain level of financial instruments to enable them to continue functioning during resolution and facilitate their recapitalization. The TLAC requirement can be met by instruments that are eligible for the minimum regulatory capital requirement. Page 27 VI: Key Takeaways VI: Key Takeaways T he survey of financial firms undertaken parent companies of local subsidiaries, foreign major for the purposes of this paper sheds useful shareholders and investors, other parts of the global light on the shifting environment for green financial industry (for example, re-insurers), and DFIs. and sustainable finance in EMDEs, as well as on The extent and depth of these individual initiatives the concerns and risks as seen by the private vary widely within and across jurisdictions, distorting sector. To be sure, the number of participants in the incentives and resulting in a patchy and uneven survey is small relative to the universe of financial playing field. Financial firms that would like to adopt firms in EMDEs, but the findings suggest common more ambitious climate or sustainability goals face patterns and shared perspectives that are valuable for a “first mover disadvantage” as a result of the fear of policymakers and market participants alike. losing market share to firms that continue business- Private financial firms in EMDEs face a number of as-usual. Absent regulatory intervention to enforce a challenges in moving toward green and sustainable common strategy and a uniform set of standards for finance. Some stem from knowledge and capacity green and sustainable finance, this may hold back the gaps, especially as regards tools and techniques for wider adoption of sustainable finance practices by assessing climate-related exposures and associated EMDE financial firms. risks, while others reflect the operating and regulatory This problem is compounded by data and capacity environment. gaps that hamper the effective application of green Nevertheless, many have already started taking and sustainable finance taxonomies and disclosure initiatives to adapt their business models and practices requirements. Although most EMDEs in the sample to address climate and sustainability concerns. These have adopted some kind of a green or sustainable include efforts to assess the climate or environmental taxonomy, these often have limited sectoral coverage, impact of exposures or potential investments, establish are not sufficiently granular, or require data and and monitor sustainability-related KPIs, incorporate knowhow that are not always available. The problem climate considerations in the credit approval process is worse in EMDEs that have imported a taxonomy and, in a few cases, withdraw from certain sectors developed in advanced economies without adapting altogether. These initiatives are not undertaken it to domestic circumstances, including the existing in response to new regulatory requirements but data infrastructure. As a result, individual financial rather to pressures coming from multiple directions: firms are often left to their own devices in assessing CHALLENGES OF GREEN FINANCE Page 28 and reporting climate-related exposures and risks. An overarching long-term transition strategy by the The inevitable inconsistencies in disclosures reduce government was seen as a key pre-condition for the the benefits of having a taxonomy, create room for successful implementation of green and sustainable “greenwashing,” and aggravate the unevenness of the finance initiatives. Respondents stressed that the competitive playing field. ultimate objective should be to “green” the whole economy, not just the financial system. Divesting Another set of challenges arises from the regulatory from carbon-intensive assets and industries may help environment. Central banks and regulators in EMDEs some financial firms “green” their balance sheets but are cognizant of climate-related financial risks, and would do little to aid the transition to a low-carbon many of them have launched initiatives to raise economy if incentives are not aligned, alternative awareness in the industry. But in most cases, they assets and sustainable technologies are not available, are behind their advanced economy counterparts in or various government policies are not coherent and incorporating climate-related considerations into their consistent with each other. Survey participants agreed risk assessment models and supervisory practices, that it is the government’s responsibility to establish as well as in disseminating tools and guidelines a national transition strategy with realistic multi-year that would allow financial firms to strengthen their targets for economy-wide greenhouse gas reductions; own management of climate-related risk. There appropriate carbon tax and pricing policies consistent is little progress toward developing system-wide with these targets; bespoke national taxonomies with quantitative scenario analyses of climate-related risk disclosure requirements for financial and non-financial in the jurisdictions covered by the survey. According companies; and steps to generate and disseminate to survey participants, this primarily reflects lack of the data required to make these classifications and data and expertise with quantitative tools, such as the disclosures meaningful. Participants stressed that climate stress tests that were used in some advanced only once such a strategy is credibly in place can the economies. financial industry play its role in the long-term process Against this background, survey participants cautioned of reallocation of capital needed to support the that, to be successful, any regulatory initiatives should transition. involve extensive consultations with the industry and As regards the role of IFC, a majority of respondents appropriate transition periods. There was widespread reported that IFC is already providing significant concern that regulators, perhaps prompted by support to their institutions in assessing climate- international standard-setters, might try to close related financial risks. This includes guidance on the gap with advanced economies without making data collection, analysis, and reporting based on adequate preparations, particularly in addressing the international standards, as well as guidance on risk gaps in data infrastructure and knowhow. There was management through dissemination of best practices also concern that regulators might adopt rules or regarding climate-related scenario analysis and stress standards developed in advanced economies without tests. IFC is also helping more generally in building adapting them to local circumstances. awareness and sharing knowledge. Some respondents Page 29 VI: Key Takeaways thought that their own firms were ahead of others in priority sectors, and macroeconomic scenarios. their jurisdiction in terms of their ability to incorporate Also important would be help in understanding climate-related risks into their strategy and decision disclosure requirements and modeling analysis making, due in part to ongoing collaboration with IFC (e.g., agricultural insurance models). or other DFIs. Others noted, however, that although • Knowledge gaps. Some respondents expressed they initially had quite a bit of interaction with IFC, this uncertainty about how IFC’s approach to had waned after initial deals were signed27. alignment with the Paris Agreement would affect Looking forward, respondents felt that IFC could their firms. Others noted confusion among various provide the most value added in the following areas: standards and reporting requirements from DFIs. • Advisory support for financial institutions to • Instruments, pricing, and streamlined processes. incorporate climate-related financial risks. This On the funding side, some respondents seemed role would include guidance on data collection, unclear about what types of instruments are analysis, and reporting based on international available through IFC. Others expressed the view standards as well as guidance on risk management that blended finance instruments from IFC and and business strategy through dissemination of other DFIs would benefit from more streamlined best practices regarding climate-related scenario processes to enable greater traction and scaling analysis and stress tests. up of investment in green priority sectors. A few respondents mentioned that IFC’s lengthy internal • Training on international best practices and new processes (without more competitive pricing) had developments. For many respondents, building led them to seek funding elsewhere. internal capacity in these areas was a key priority. IFC could contribute through engaging in staff training activities with individual financial firms, banking associations, the ongoing work with the Sustainable Banking and Finance Network, and in conjunction with financial regulators. • Data and tools. Several respondents reported that their institutions would benefit from upgraded tools to incorporate climate risks and opportunities. These would include tools to assess climate risks in exposures, sector-level data that would facilitate identifying funding needs in These interviews to survey financial firms were conducted in FY22. IFC’s “Strategy and Business Outlook, FY24-26: Extending Our Ambition” details how innovations put in place under 27  IFC 3.0, including a greater focus on development impact and streamlining operations, have been bearing fruit. The near-term outlook will be shaped by growing client needs and the opportunity to pioneer new approaches, technologies, and business models. See https://www.ifc.org/content/dam/ifc/doclink/2023/ifc-strategy-and-business-outlook-fy24-26.pdf. CHALLENGES OF GREEN FINANCE Page 30 Annex: Topics for Discussion in Survey Interviews This is an indicative list of topics, not an exhaustive inventory of issues. We welcome any input on any topic, even if not covered directly by the questions below. Mentions of the “financial regulator” below refer to the agency or agencies responsible for macro- and micro-prudential supervision and financial stability policy in your jurisdiction. Responses to this survey will be treated confidentially. Climate change impacts: institutions and market participants (conferences, meetings with industry associations, etc.) to discuss What are the impacts of climate change (‘physical how climate-related issues might affect the financial risk’, such as severe weather events, flooding, etc.) or sector? Has it initiated consultations on possible future of climate mitigation policies (‘transition risk’, such as changes in regulations in response to climate-related the effects of taxes on emissions, carbon pricing, etc.) concerns? Has your company (or other companies on your company? How do these factors affect your in your sector) begun the process of adjusting your business model (e.g., credit origination and credit risk portfolio or your operations as a result of changes for a bank, or underwriting policies for an insurer)? (or expected changes) in national climate policy and Will there be new business opportunities as a result of financial regulations? these factors? Regulatory and policy measures: Financial regulator engagement: Has the financial regulator in your jurisdiction Is the financial regulator in your jurisdiction aware introduced requirements or supervisory expectations of the global climate-related regulatory initiatives? for financial firms to collect and analyze data on Has it engaged in any type of outreach to financial Page 31 Annex: Topics for Discussion in Survey Interviews climate-related risks on their balance sheets? Has the from the transition to a low-carbon economy? (this financial regulator taken measures to incorporate could, for example, include improving climate risk climate-related considerations in the supervisory analysis; help in restructuring your portfolio to lower process for financial firms? If so, do these apply to climate-related risks; expertise to identify climate- all financial firms or a subset (e.g., larger or systemic neutral investments; assistance in issuing green bonds; firms)? What has been the impact of these actions on improving data collection, CO2 tracking, and carbon the business model of supervised firms? How large are credit management; etc.) the compliance costs? Are there other policy measures to align with Paris Agreement commitments or to promote green finance strategies that currently or will soon affect your company or sector? Green taxonomies and standards: Are there environmental or ‘green’ taxonomies or standards in your jurisdiction that financial companies, issuers, or investors use to classify ‘green’ or sustainable investments or assets? If so, are these mandatory or voluntary? In your view, how successful is the application of these standards in directing credit and investment flows to environmentally sustainable projects? Are there improvements that can be made? If not, what benefits might such standards provide, and what challenges might you foresee? Role of regulators: What are your views about the appropriate role of financial policy and regulation in the transition to a low-carbon economy? What would be the key benefits and risks of a more ‘active’ role for central banks and regulators in promoting decarbonization? How is the financial sector in your country(ies) of operations likely to be affected? Role of IFC: What role could IFC play in helping your company (or others in your sector) to deal with the consequences The material in this work is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. IFC does not guarantee the accuracy, reliability or completeness of the content included in this work, or for the conclusions or judgments described herein, and accepts no responsibility or liability for any omissions or errors (including, without limitation, typographical errors and technical errors) in the content whatsoever or for reliance thereon. © International Finance Corporation 2023. All rights reserved. 2121 Pennsylvania Avenue, N.W. Washington, D.C. 20433 Internet: www.ifc.org