Investor Playbook Seeks to Unlock Adaptation Capital
The Adaptation and Resilience Investors Collaborative argues that understanding of risks will increase appetite for emerging markets adaptation investment opportunities.
A coalition of development finance institutions (DFIs) has developed a step-by-step guide to help investors understand their exposure to physical climate risks, in a bid to increase private capital toward adaptation investment opportunities.
The Adaptation and Resilience Investors Collaborative (ARIC)’s investor playbook builds on the physical risk equation established by the Intergovernmental Panel on Climate Change (IPCC) and is asset class-agnostic, applying to the provision of capital across both equity and debt instruments.
“It [the equation] gives us a template through which to think about the key drivers of physical risk, climate hazards and exposure,” said Dr Chiara Trabacchi, Climate Change Manager at British International Investment (BII), the UK’s DFI, at a webinar launching the playbook.
“Investors – be it public or private – can apply our framework throughout each stage and integrate it into their existing processes.”
The framework recommends that investors screen for physical climate risks across their assets, determine the financial materiality of those risks through a vulnerability assessment, identify adaptation and resilience solutions, and monitor investee companies’ progress implementing mitigating physical risks.
It also encourages investors to leverage existing guidance – such as the Task Force on Climate-related Financial Disclosures and the International Sustainability Standards Board’s climate reporting standard – to inform their risk assessments.
A greater understanding of the impacts of physical risks on investments is seen as necessary to directing more capital to projects that increase adaption and resilience to climate change.
This would unlock the private finance needed to plug the climate adaptation funding gap, which the UN Environment Programme’s Adaptation Gap Report 2023 has estimated sits between US$194 billion and US$366 billion per annum. An updated report will be published before COP29.
Ongoing engagement
The ARIC playbook focuses on the physical-related financial risks that may arise from the adverse effects of extreme weather events, such as crop loss and a decline in yield quality for agriculture businesses due to drought.
“Physical risk assessments are very dynamic and evolve throughout the life of an investment – it’s not static at a point in time – and so it requires ongoing engagement by investors,” said Trachacci.
Investors should aim to conduct due diligence of investee companies regularly, the report said – a process which may also entail engagement of a third-party expert – such as an engineering company or investment consultant – to evaluate the key operational thresholds of a manufacturing plant, for example.
“The importance of listening to people on the ground and recalibrating assumptions based on site-specific contexts cannot be overstated,” added Alec Martin, Director of Impact and ESG at AgDevCo, a specialist investor in African agribusiness.
In engaging directly with portfolio holdings in emerging markets on addressing the physical climate risks that most impact them – such as drought – the firm has seen success through the implementation of regenerative agriculture practices and climate-resilient livestock, underscoring the value of collaboration and shared learnings, he said.
“Quite often, we [investors] can be tempted to project our assumptions about how risks will affect a business, but we need to listen to the people on the ground about this – quite often, we will find that our historic weather data for a site is wrong as it’s not relevant to the specific context today,” he said.
Risk to opportunity
The need to assess physical risks to existing portfolios and invest in climate resilience has risen up the agenda for asset owners, but many feel they do not have the tools or expertise to fully address the issue.
An investor survey earlier this year found that the majority were concerned physical climate risks will have a significant impact on their infrastructure assets – with most admitting they did not know how to measure or mitigate such risks.
But new tools are emerging to help investors. In August, the Institutional Investors Group on Climate Change completed the first pilot phase of the Physical Climate Risk Assessment Methodology (PCRAM).
More recently, the Climate Bonds Initiative (CBI) published the Climate Bonds Resilience Taxonomy (CBRT), which aims to help channel debt finance towards climate resilience and adaptation by defining what constitutes a ‘credible’ investment in these areas.
Informed by the Resilience Taxonomy Advisory Group, the CBRT introduces criteria across seven themes, including agrifood systems, health, and infrastructure.
“It is critical for investors to have a full understanding of the physical risk profile of an investee, which includes their adaptive capacity,” said Trachacci.
“By the time an investor exits, or by the time of maturity, what we want to see happening is that the physical rating profile of the investee has improved.”
ARIC is an international partnership of DFIs working to accelerate private investment in climate adaptation and resilience in developing countries. It has focused its work across three development workstreams: investor-relevant metrics for adaptation and resilience, capital mobilisation approaches, and physical climate risk assessments.
Earlier this year, ARIC published a climate adaptation and resilience impact measurement framework for investors.
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