The new year has ushered in significant headwinds for the sustainability agenda, with the initial momentum sparked by the Sustainable Development Goals and the Paris Agreement now paving the way for a more nuanced reality.
This shift is being driven by the changing global policy and regulatory landscape, as some commitments to international climate agreements are being reconsidered. Simultaneously, regulators and supervisors— who once championed links between sustainability and financial stability — are now reassessing their strategic approach. Discussions about simplification and potential deregulation challenge the previous drive for more stringent accountability and sustainability disclosures across economies.
However, this regulatory recalibration is occurring against a growing backdrop of scientific evidence that global warming must be limited to 1.5°C but that this target is increasingly out of reach.
A growing emphasis on physical risk
Thus, while the timelines for delivering the net-zero transition remain under review, the urgency of addressing physical climate risks has never been more pressing. This was graphically evidenced by the recent Los Angeles wildfires, Panama’s evacuation of the sinking islandof Gardi Sugdub, and the devastating floods across Brazil’s Rio Grande do Sul state. Indeed, the annual cost of responding to the impact of climate change, for developing countries alone, is estimated at between $160-340 billion by 2030.
Globally, these political headwinds require new approaches across finance; one that balances the continuing need for climate mitigation but complemented by a more robust focus on physical risk management.
In climate risk terminology, this shift means a rebalance of ‘transition’ versus ‘physical risk’, with a focus more heavily on the latter.
What this means for finance
Physical risk, so far, has been far less explored by the finance sector, presenting significant challenges in assessment, quantification, and financial management. The financing of adaptation also requires greater creativity and vision if more robust financial returns are to be achieved.
International financial organisations, particularly development banks, will continue to play a crucial role in providing access to adaptation finance. This is because they are well-positioned to provide both financial support and technical expertise for projects that often struggle to attract private investment due to their long-term nature and uncertain returns. Opportunities include:
- Financing climate-resilient infrastructure, like flood defences and drought-resistant water systems.
- Supporting climate-smart agriculture practices and technologies.
- Funding nature-based solutions such as mangrove restoration for coastal protection.
- Investing in green urban infrastructure and heat-resilient building designs.
From a financial institution perspective, the sector must update and improve its modelling of physical risk while reassessing the value of assets to manage the increased risk impacting certain clients, industries, and regions now face. There will also be commercial opportunities stemming from supporting clients to address their exposure to the impacts of climate change.
While adaptation efforts may not deliver in time to fully address the surge in physical risks, already impacting vulnerable parts of the world, the finance sector must significantly improve its data, models, and integration of physical risk assessments alongside their existing transition finance activities. Priorities include:
- Enhancing capabilities in assessing and quantifying physical climate risks across various sectors and geographies.
- Developing technical expertise to help structure, evaluate and/or finance adaptation projects and their unique risk-return profiles.
Regardless of the political headwinds, the reality for finance is that it has no choice but to continue to evolve to the continuing realities it – and its clients – increasingly face from the risks and opportunities the climate crisis presents, only now with a growing emphasis on upskilling around adaptation and resilience.
Written by WeESG co-founder and Chief Knowledge Officer Clarisse A. Simonek
