Understanding and reporting on the potential physical effects of climate change on green bonds:
Affirmative Investment Management (AIM), an industry leader in impact bond asset management, continues to pioneer best practice in green bond verification and reporting, drawing on its groundbreaking research into climate-related financial disclosure in collaboration with leading climate solution providers, South Pole.
The case study's first-of-a-kind, comparative benchmarking of green bond frameworks and issuers' exposure to physical climate risks reveals that green assets can still be vulnerable to climate-related physical risks. The results come on the heels of the IPCC Special Report on Global Warming, which calls into question the resilience of current climate mitigation and adaptation vehicles, such as projects financed by green bond use of proceeds. The case study is a pilot, and the analysis contained can be further applied to green bonds and non-green bonds.
Greater disclosure of adaptive capacities will enable deeper engagement between issuer and investor
Using an innovative new climate risk assessment tool from South Pole, AIM has explored how it can better understand the physical climate-related risks of its portfolios, as recommended by the TCFD guidelines for future-proofing investment strategies. Headline findings from this pilot reveal that improved reporting, to include elements of the adaptive capacity of projects, is highly beneficial to both issuers and investors—not only in raising their profile of climate resilience in the market, but also for facilitating improved engagement on the topic.
"AIM strongly believes that establishing dialogue with companies or issuers is part of being an active owner of bonds. While active ownership and engagement are typically associated with equity investors, bondholders—as providers of debt funding to companies or other issuers—are also able to influence practices. In this context, AIM uses its position to advocate fair, responsible and sustainable business practices—cutting-edge information tools, such as South Pole's climate risk tool, empower investors to have a constructive and technical dialogue with issuers on climate risk," says Stuart Kinnersley, Managing Partner, AIM.
New risk assessment tools required to improve adaptation strategies
AIM's exercise, focusing on a select sample of green bonds, reveals that an issuer's overall level of exposure to physical climate risks can vary significantly when modelled for 2°C warming and 4°C warming scenarios. This exposure could signify negative impacts on revenue-generating activities that could result in up to a 50% decrease in output. The results also show that the physical risks are similar (+/- 5%) for the issuer's overall risk and the green bond framework. The tool can also be applied to non-green bond issuers to enable comparative benchmarking.
These forward-looking risk assessments provided by South Pole's new risk assessment tool analysed the exposure of the issuer based on its activities. The results provide an indication of the issuer's overall exposure to physical climate risk, such as high levels of rainfall leading to flooding, and whether necessary adaptive measures have been taken to protect their assets. Such new tools offer a welcome addition to the reporting frameworks for green bonds that, at present, do not extend to the forward-looking physical risks of climate change, which can have a direct effect on revenue generation assets, threatening the financial stability of some issuers. Findings from the tool could also be used to assess and illustrate the climate resilience of the green bond market versus other markets.
"AIM, as a progressive investor, has undertaken some game-changing analysis for the green bond market. Physical risk modelling and data tools, such as South Pole's climate risk assessment tool, empower investors to raise the profile of climate resilience in the market and enable deeper engagement between issuer and investor on the topic. The development of the tool is intended to encourage greater disclosure on climate risks and adaptive capacities of green bond issuers at both the framework and issuer level," says Franziska Sinner, Head of Advisory - Corporates and Capital Markets, South Pole.
Download the full case study here.
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