The Taiwan Banker

The COP28 summit played a pivotal role as global economies converged to address the pressing issue of climate change. The event witnessed a strong global presence of world leaders participating in the theme of mobilizing finance for sustainable development and energy transition. The essence of COP28 revolved around the basic principle of transparency, which is central to climate issues. Setting mechanisms for transparently reporting and analyzing climate related issues opens a plethora of opportunities for the financial sector. Throughout the history of economic development, the financial sector has always played an important role, making important contributions through various stages of business cycles. Comprehensive transparent reporting on emissions is likely to have implications for multiple touchpoints that the finance sector has with the real economy. These symbiotic relationships have the potential to steer the industry towards positive change, contributing to greater global growth. For instance, the UAE has pledged $270 billion in green finance by 2030 through its banks to address the gap in climate finance needs. We will focus on three key touchpoints: risk management, fintech, and investment products. Risk Management: Conventionally, financial risk management has limited itself to assessment of financial ratios, market exposure, and regulatory shocks. However, the integration of comprehensive emissions reporting introduces a novel dimension to risk assessment. Transparent reporting allows institutions to quantify not only their own carbon footprint but also the entities in which they invest or insure. This includes assessing the impact that events due to climate change can have on the balance sheet. Each portfolio will have a corresponding carbon footprint metric that will need to be tracked and the implied risk will need managing by reducing exposure. Similarly, the insurance sector may undergo significant shifts with comprehensive ESG (Environmental, Social, and Governance) reporting. Conventionally, insurance risk assessment has heavily relied on historical data and fitting in actuarial based projections. Most of these risk factors which feed into these models are quite well established. ESG factors present a novel opportunity. The integration of comprehensive ESG reporting standards will not only introduce a forward-looking perspective, but also enable the insurers to holistically quantify the entailed risks. As the world grapples with climate-related events at increasing frequency and intensity, such assessment becomes even more pivotal. Moreover, quantifying the risks inherent in environmental dimensions allows for more accurate pricing of insurance policies, and thereby, the insurance premiums. This expanded view provides a more holistic understanding of risks associated with climate change. Fintech Products: Fintech platforms can develop tools and applications that provide users with real-time access to companies' emission data or carbon footprint of products. Fintech companies can employ advanced analytics and machine learning algorithms to assess climate-related risks, offering tailored financial products that align with sustainability goals. Smart contracts powered by AI on blockchain platforms can automate and enforce ESG-related agreements, ensuring transparency and accountability in sustainable finance transactions. With the advent of technological advancements even the remotest and underserved regions of an economy can be duly served through digital financial services ensuring economic growth and promoting sustainability. Innovative Investment Instruments: COP28 commitments are likely to encourage the use of climate-conscious financial instruments, such as green bonds and sustainable loans. For instance, the UAE has experienced a remarkable increase in ESG bonds, reaching $6.4 billion in 2023. The contribution by UAE ESG bonds accounts for 19% of the global ESG bond market. Fintech may play a pivotal role in the development, implementation, and provision of a platform to ensure proper issuance and trading of such bonds can be done with efficient monitoring. An important topic in the same area is Green Finance initiatives, involving investments in renewable energy projects and businesses that are environmentally friendly. These have the potential to not only contribute to funding projects which are pro-climate risk but also be a viable alternative for portfolio diversification. ESG bonds, by design, prioritize investments based on environmental, social, and governance criteria. These instruments can contribute to a diversified portfolio by offering exposure to sectors less correlated with traditional economic shocks. Moreover, with increasing popularity due to global events such as COP28, these early markets are likely to attract a broader investor base thereby fostering liquidity. Further, advanced analytical tools can be developed to integrate ESG factors into investment decision making at a micro, individual investor level. The creation of novel investment vehicles such as ESG-focused exchange-traded funds (ETFs), and impact investing funds will allow investors to direct their capital towards companies and projects that demonstrate strong ESG practices. However, one must also be aware of how the introduction of these financial instruments can lead to the substitution of resources from the conventional asset classes. This will most certainly impact the transmission of shocks via the banking sector and thereby impact the relative distribution of economic resources. Conclusion: As the world converged at COP28 to structure the initiatives on climate crisis, the impact of the financial industry on fostering the ideas of United Nations Climate change secretariat cannot be overstated. Banks and financial institutions are well positioned to be the conduit for innovative market instruments and frameworks. There is no doubt that leveraging the multiplier-effect of the financial sector will be an important piece in the puzzle for a more sustainable future. Dr. Allen Baby is a dynamic senior C-suite multi-faceted professional with global exposure, leading the Learning function at the UAE’s National Financial Training Institute, Emirates Institute of Finance (EIF), part of the Central Bank of UAE, governed under Chairmanship of H.E Governor of UAE Central Bank.