As discussed in the previous post, one of the key risks in climate finance derives from the fact that a financial institution’s loans could contribute to climate change. The most important factor, especially in the Asia-Pacific region, is when forests or other land is developed for farming (known as forestry and other land use––FOLU). For example, with regard to agriculture financing, the European Union requires that loans cannot be made for agricultural activities that are carried out on land that was previously deemed to be of “high carbon stock”.
Although it is critical that financial institutions ensure that their loans do not contribute to climate change, this is the minimum standard for green finance. Excluding such loans also does not help the financial institution grow its portfolio. Addressing climate issues and growing the portfolio requires financial institutions to proactively make loans.
There are many different types of climate related activities that need financing. Based on the draft EU sustainability reporting standards developed by the European Financial Reporting Advisory Group (EFRAG) and approved as of 22 November 2022, the typology of climate related loans includes:
- Mitigation
- Adaptation
- Promoting biodiversity and eco-systems, including water and marine resources
- Reducing resource usage through circular practices
- Pollution prevention
Although this long list may appear to give financial institutions a broad array of opportunities to increase their pipeline, it is not as easy as it sounds. This kind of lending differs from conventional lending in one important way: whereas normal investment or working capital loans can be used for a wide variety of purposes, the usage of green loans must be directed toward specific technologies. These technologies must be appropriate for the context, available, accessible, affordable, and accepted by clients. This means that effective green lending requires more than a well-designed product––at a minimum, it requires partnerships (with technology providers), promotional schemes, and monitoring tools that are significantly more advanced than for regular loans.
Climate change mitigation
To date, the most well-developed financing standards involves mitigation: financing investments that reduce GHG emissions. As early as 2015, the “Common Principles for Climate Mitigation Finance Tracking” were developed by the joint climate finance group of multilateral development banks (MDBs) and the International Development Finance Club (IDFC) based on their experience on the topic and with the intention to be shared with other institutions that are looking for common approaches for tracking and reporting.
The overall definition of climate change mitigation is the promotion of “efforts to reduce or limit greenhouse gas (GHG) emissions or enhance GHG sequestration”. The list of activities eligible for classification as climate mitigation finance is extensive and covers areas such as:
- Improving energy efficiency
- Renewable energy
- Increasing the carbon stock in the soil
- Avoiding loss of soil carbon through erosion control measures
- Reducing non-CO2 GHG emissions from agricultural and animal husbandry activities
Climate change adaptation
The overall definition of climate change adaptation is “addressing current and expected effects of climate change”. Adaptation can include protecting any physical asset against a natural disaster such as a flood. However, most of the deeper work on adaptation is applied to agriculture. Building resilience against climate change in agriculture can involve, for example, managing water resources, drought-resistant farming practices, increasing soil fertility, crop insurance, and diversifying farm household income.
Another key area is climate-smart agriculture, which includes conservation agriculture, access to climate information, agroforestry systems, drip irrigation, planting pits and erosion control techniques. Other adaptation measures include:
- Biological agriculture, permaculture, agroecology, agroforestry
- Proven ecosystem-based adaptation solutions such as soil covering based on organic cover or micro-catchment water harvesting
- Advanced modern undercover growing solutions adapted to specific crops and local climate
- Locally manufactured protected cultivation solutions (net shade or poly houses or structures) adapted to specific crops and local climate
- Hydroponics solutions
- Production and/or commercialization of bio and organic fertilizer and pesticides
- Improved post-harvest solutions
- Water storage facilities
- Precision irrigation and fertigation
- Storage facilities for crop conservation and protection
- Digital farming systems
- Economic diversification activities such as aquaculture, aquaponics systems,
- Agronomic optimization techniques such as season duration and planting time management services
- Early warning systems for climate risk assessments
Common standards for adaptation finance are still being developed. The difficulty with adaptation finance for lenders is that the impact is difficult to measure and monitor.
To be continued.