Introduction:
The world, standing at the precipice of a climate crisis, is confronted with unparalleled challenges: record-breaking heatwaves, devastating floods, and wildfires that alter entire landscapes. These calamities, while immediately catastrophic, cast a profound, long-lasting shadow on the global economy. Beyond the palpable human anguish, there's an emerging economic narrative that remains largely beneath the surface. This article aims to illuminate the intricate financial tapestry woven with climate change, emphasizing the concept of "Climate Dollars" to quantify its implications. For instance, US residential properties exposed to flood risk are currently overvalued by a staggering$121bn to $237bn. Moreover, the agricultural sector, a cornerstone of many economies, faces potential losses of up to $314bn annually due to climate-induced disasters. Latin America, with its vibrant market dynamics, stands at a unique intersection of these challenges. From the bustling construction sites of São Paulo to the innovative fintech hubs of Colombia, the region resonates deeply with the repercussions of climate change. Institutions, from traditional banking stalwarts to fintech trailblazers, are at this crossroads, navigating the intricate maze of risks and opportunities that the evolving financial landscape presents.
Underpriced Climate Risks: A Financial Time Bomb
The global financial system, despite its vast data sets and intricate algorithms, often stumbles when it comes to accurately pricing climate risks. This isn't just a minor oversight—it's a looming financial catastrophe. For instance, US residential properties exposed to flood risk are currently overvalued by an astonishing $121bn to $237bn. Such miscalculations can lead to what experts term a "climate Minsky moment"—a sudden and severe correction in asset values when investors collectively recognize the unsustainability of their investments. This is not only happening in real state assets in the US. Its occurring in different asset classes all over the world.
But why does this underpricing persist? One significant reason is the immense challenge of mapping the interactions between the assets and green house gas emissions. Industry specific effects of climate are not completely mapped today. And the concept of double materiality becomes abstract when applied to metrics like Air Quality Index, PPM or the different scopes of emissions. While equities have not adequately priced in climate change risks, the perceived distance of risks, such as sea-level rises, further muddies the waters. Historically, businesses and investors have been more engrossed in the costs and risks of decarbonization than on the direct physical effects and adaptation strategies for climate change. In latAm, companies have few to none voluntary, consistent, climate-related financial risk disclosures to allow investors, lender and insurers or other stakeholders to take informed decisions about their investments. It’s a tipping point in asset valuation that will come with destruction of wealth for the region because of the absence of fiduciary duty. Particularly in TheAlliance of Small Island States and other countries in the Pacific and Caribbean that are more likely to be the most affected by rising sea levels, extreme weather and other effects of global warming, and for agriculture, forestry and other land use players.
The Rationale Behind "Climate Dollars"
In the complex world of finance and environmental science, there's a pressing need to bridge the gap between the tangible impacts of climate change and their financial implications. While we've seen terms like "carbon credits" and "carbon footprint" gain traction, they often focus on the environmental side of the equation. What's been missing is a term that encapsulates the monetary implications of climate risks—a term that speaks the language of investors, policymakers, and the general public alike.This is where "Climate Dollars" comes into play.
"Climate Dollars" is more than just a term; it's a paradigm shift. It represents an effort to quantify the financial implications of climate change in a manner that's both comprehensible and actionable. By translating the often abstract and intangible effects of climate change into a monetary value, "ClimateDollars" offers a clearer picture of the financial stakes at hand.
Furthermore, as various entities strive to measure climate risks in monetary terms, there's an inherent challenge. The vastness and complexity of climate change effects make it difficult to pin down a precise dollar value. However, the effort to do so is not just about accuracy; it's about creating a sense of urgency and understanding. "Climate Dollars" serves as a beacon, guiding these efforts and providing a practical solution that if backed correctly can help understand the financial implications of our changing climate.
LatAm: Amplified Risks and Opportunities
Latin America stands at a unique intersection. The region faces amplified risks due to its geographical and socio-economic landscape. The disasters of 2022 alone, with losses reported at over 42 billion US dollars and affecting more than 83 million people, underscore the region's vulnerability. From theAmazon rainforest's rapid deforestation to the melting Andean glaciers, the signs are evident. But it's not just about the environment. The financial markets in LatAm are also feeling the heat.
For instance, the construction industry in major cities like São Paulo or Mexico City must now factor in changing weather patterns, leading to increased costs. The energy sector, especially in countries likeVenezuela or Brazil, is grappling with fluctuating oil prices, compounded by the global push towards sustainable energy. And the agricultural sector, a significant contributor to many LatAm economies, faces unpredictable crop yields due to erratic weather patterns. Transportation is also an industry that carries a significant amount of climate dollars.
The Panama Canal Crisis: A Glimpse into the Cost of Climate Inaction
The Panama Canal, a pivotal artery of global trade, connecting nearly 2,000 ports across 170countries, has recently faced an unprecedented challenge. A severe drought, one of the worst in its history, has led to long delays and stringent restrictions on one of the world's most vital trade routes. This drought, a direct consequence of climate change, has forced the canal to lower the number of crossings and even bar ships with heavy loads.
To put this into perspective, the canal requires a staggering 101,000 cubic meters of water every day.With the drought, the canal's watershed experienced its second driest year in almost a century. This scarcity led to the imposition of a "Panama Canal Charge (PCC)" of $260 per container, translating to around $1.1M per vessel.
The direct financial implications of the Panama Canal's challenges are staggering. In just 21 days, shipping delays, additional charges, and potential revenue losses could cost a whopping $664 million.But this is merely scratching the surface. The hidden, indirect "Climate Dollars" are where the real impact lies. If we consider a really conservative 1% hike in commodity prices due to supply chain disruptions, contractual penalties amounting to 0.5% of the value of delayed goods, and a 0.1%efficiency loss across industries affected by these delays, the indirect costs balloon to an estimated$4.32 billion. In total, the Panama Canal crisis could be siphoning off nearly $5 billion from the global economy in 21 days. To put it in perspective, that's equivalent to the GDP of some small countries. These numbers are a clarion call, highlighting the dire need for proactive adaptation measures and the exorbitant price of complacency in our changing climate.
The term "Climate Dollars" was coined to quantify these implications, especially in regions like LatinAmerica. The Panama Canal's situation is a stark reminder of the need for proactive investment in adaptation measures. The cost of inaction, as evidenced by the canal's crisis, can be astronomical.The canal's recent expansion in 2016, a $5bn project to accommodate larger ships, now faces challenges as these bigger vessels are more likely to be affected by the restrictions due to their heavier loads. According to the ACP the potential loss for the canal could reach up to $200mn in revenue this year for Panama, which by itself justifies a much larger investment to solve this.
In essence, the Panama Canal's crisis underscores the urgent need for adaptation investments. It's not just about environmental conservation; it's about ensuring economic sustainability and profitability in the face of climate change. As the world grapples with the tangible impacts of a changing climate, it's not just about ESG (Environmental, Social, and Governance) metrics or saving the planet. It's about the return on investment.
The Role of Finance and the Emergence of Climate Dollars in LatAm
For financial institutions in Latin America, the changing climate presents both a challenge and an opportunity. Traditional banks and emerging fintechs can play a pivotal role in driving sustainable investments, promoting green technologies, and supporting businesses that prioritize climate resilience. The emergence of "Climate Dollars" in the region could be the catalyst for a financial revolution, one that values sustainability and long-term growth over short-term gains.
The ESG Paradox and the Emergence of Climate Dollars
Recent research has unveiled a perplexing reality: companies rated highly on widely accepted environmental, social, and governance (ESG) metrics pollute just as much as their lowly-rated counterparts. This lack of correlation is especially stark when considering only the environmental component of these ratings. For instance, ESG ratings have shown little to no relation to **carbonintensity**, a measure of carbon dioxide emissions relative to a unit of revenue for a company or relative to GDP for a country. Such findings challenge the prevailing notion that ESG investments inherently contribute to a greener future.
This raises a pivotal question: Can the concept of ESG truly align with the pressing need to address climate risks? The answer lies in the emergence of "Climate Dollars"—a concept that quantifies the financial implications of climate change. It's not merely about adhering to ESG standards; it's about understanding the tangible financial risks posed by climate change and making informed investment decisions accordingly.
Major financial institutions like BlackRock and Vanguard are at the forefront of promoting ESG(Environmental, Social, and Governance) tools. Their advocacy isn't just about corporate responsibility or environmental stewardship—it's about ensuring returns on investment. But ESG, Bloomberg Scoresand MSCI are not enough. The TCFD, TNFD, science based target and other frameworks are also not enough. They are needed and we need to keep improving on them, but the climate valuation of a company today should not be heavily influenced only by if they are in line with what the latest climate science deems necessary to meet the goals of the Paris agreement to limit global warming to well below 2C above pre-industrial levels and pursuing efforts to limit warming to 1.5C. Specially in a scenario where the carbon market grows, because it will shift our focus from zero carbon to net zero.As the world becomes increasingly vulnerable to extreme weather events, outdated assumptions about asset values need recalibration. The potential for a sudden correction in asset values, as investors simultaneously realize these values are unsustainable, is a looming threat that we do not need to suffer.
These financial behemoths recognize that natural resource-intensive businesses carry heightened risks in a climate-challenged world. While ESG tools remain valuable, they are increasingly seen aspart of a broader toolkit that includes more targeted metrics, such as carbon intensity. It's not just about corporate responsibility or environmental stewardship—it's about safeguarding returns on investment. As the world grapples with the tangible impacts of climate change, the financial sector must evolve, prioritizing not just ESG but also the broader financial implications encapsulated by"Climate Dollars."
Adaptation Interventions: Research shows that adaptation projects often overlook important factors of vulnerability and can create new forms of vulnerability. The Panama Canal's recent crisis is a testament to this, where a significant adaptation project, the canal's expansion in 2016, now faces challenges due to climate-induced droughts.
Risk Communication: Effective risk communication is a critical component in disaster risk reduction.For instance, the Panama Canal's drought and its subsequent financial implications needed to be communicated effectively to stakeholders, from shipping companies to global investors. Such communication is essential, as seen in examples like flood risk communication in Nepal.
Climate Justice: Ignoring climate change when it is a major factor in a hazard has implications forloss, damage, and climate justice, leading to a lack of preparedness and increased losses and damages.
The Role of Finance and the Emergence of Climate Dollars in LatAm
Latin America, with its rich biodiversity and unique climatic challenges, is at a pivotal juncture.Financial institutions, both traditional and emerging fintechs, have a monumental role to play. They can be the catalysts driving sustainable investments, championing green technologies, and bolstering businesses that prioritize climate resilience.
Recent data from ECLAC underscores the urgency. Since 2013, Latin America has consistently received climate finance of around US$20 billion annually. In contrast, East Asia and the Pacific have witnessed flows nearing US$292 billion per year. This disparity is further magnified when we realize that a significant portion of this finance in Latin America is concentrated in just six countries.
But the real concern lies in the allocation of these funds. Mitigation activities, which primarily focus on reducing greenhouse gas emissions, receive six times more funding than adaptation activities. This is alarming for a region like Latin America, where the impacts of climate change are immediate and palpable.
The "Common Framework of Sustainable Finance Taxonomies for Latin America and the Caribbean"provides a structured approach to address this.
The framework emphasizes clear, science-based definitions for environmental sustainability and aims to strike a balance between standardization and local context. It serves as a guide for market participants to identify projects and activities that are environmentally sustainable, ensuring investments align with countries' environmental priorities.
A notable example of adaptation from the report is the emphasis on activities that support climate change adaptation, which often requires qualitative metrics or detailed studies such as vulnerability risk assessments. These are location-specific, and the screening criteria used for such assessments are pivotal. The report highlights the importance of:
-Preference for nature-based solutions like Sustainable drainage systems (SuDS).
-Protection of natural capital, including wetlands and mangroves.
-Effective management of watersheds and aquifers.
-Promotion of blue and green infrastructure.
-Improvement of stormwater drain capacities for urban infrastructure.
-Water management and storage.
-Monitoring and meteorological systems for weather events.
-Ensuring resilience of potable and wastewater infrastructure.
⠀Furthermore, the Green Bond Transparency Platform is a testament to the importance of clear screening criteria. It ensures that investments are not only environmentally sound but also transparent, traceable, and aligned with the broader goals of climate resilience.
For investors, the narrative is clear. It's not about altruism or corporate social responsibility; it's about financial prudence. Overlooking the urgent need for adaptation funding in Latin America means exposing portfolios to heightened risks. In an era marked by climate-induced economic shifts, de-risking portfolios by investing in adaptation is not just strategic; it's imperative.
One can't help but wonder when venture capitalists and other investors will recognize this. The recent crises, from the Panama Canal droughts to the Amazon wildfires, are glaring indicators of the tangible financial repercussions of climate inaction.
In essence, investing in adaptation in Latin America isn't about saving the planet; it's about safeguarding investments. It's about recognizing the vast untapped potential of a region on the frontline of climate change impacts and ensuring financial strategies are resilient against these challenges. It's high time we understand the true value of "Climate Dollars" and act on it.
Bibliography
Gourevitch, J. D., Kousky, C., Liao, Y., et al. (2023). Unpriced climate risk and the potentialconsequences of overvaluation in US housing markets. Nature Climate Change, 13(3), 250-257.~[https://doi.org/10.1038/s41558-023-01594-8]()~
Otto, F.E.L., Raju, E. Harbingers of decades of unnatural disasters. Commun Earth Environ 4, 280(2023). ~[https://doi.org/10.1038/s43247-023-00943-x]()~
Feingold, S. (2023, August 22). Drought at the Panama Canal poses unprecedented challenges toglobal trade. World Economic Forum. ~[https://www.weforum.org/agenda/2023/08/drought-at-the-panama-canal-poses-unprecedented-challenges-to-global-trade/]()~
LaRocco, L. A. (2023, August 9). Panama Canal shipping pileup due to drought reaches 154 vessels.CNBC. Retrieved from ~[https://www.cnbc.com/2023/08/09/panama-canal-shipping-pileup-due-to-drought-reaches-154-vessels.html\#:~:text=Starting%20on%20July%2030%2C%202023,34%20to%2036%20a%20day]()~.
Sultan, K. (2023, August 21). Huge backlog of 200 ships stuck trying to enter Panama Canal as theywait WEEKS amid slowed traffic from drought. Delays set to wipe $200M in profits and cause spike ingrocery, parcel prices. Daily Mail. Retrieved from ~[https://www.dailymail.co.uk/news/article-12427501/Huge-backlog-200-ships-stuck-trying-enter-Panama-Canal-wait-WEEKS-amid-slowed-traffic-drought-Delays-set-wipe-200M-profits-cause-spike-grocery-parcel-prices.html]()~
Moreno, E. (2023, August 11). Traffic jam at Panama Canal as drought lowers water level. The SydneyMorning Herald. ~[https://www.smh.com.au/world/central-america/intense-drought-causes-panama-canal-traffic-jam-not-enough-water-for-locks-20230811-p5dvoh.html]()~
Murray, C. (Mexico City) & Telling, O. (London). (2023, August 14). Severe drought in Panama hitsglobal shipping industry. Financial Times. Retrieved from ~[https://www.ft.com/content/86839bc7-1926-4bf6-b593-1720f7fbd8b4]()~
Gourevitch, J. D., Kousky, C., Liao, Y. (P.), et al. (2023, February 16). Unpriced climate risk and thepotential consequences of overvaluation in US housing markets. Nature Climate Change. ~[https://doi.org/10.1038/s41558-023-01594-8]()~
Houlder, V., & Thomas, N. (2023, August 16). Lex in depth: how investors are underpricing climaterisks. Financial Times.
Johnson, S. (2023, July 30). Companies with good ESG scores pollute as much as low-rated rivals.Financial Times.
United Nations Environment Programme. (2023, July 30). Common Framework for SustainableFinance Taxonomies for Latin America and the Caribbean. Retrieved from ~[https://www.unepfi.org/publications/common-framework-for-sustainable-finance-taxonomies-for-latin-america-and-the-caribbean/]()~
"Climate change A to Z: an FT jargon buster." (2023, June 6). Financial Times. Retrieved from ~[https://www.unepfi.org/publications/common-framework-for-sustainable-finance-taxonomies-for-latin-america-and-the-caribbean/]()~
